These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. ETF Basics. Main Types of ETFs. ETF Variations. ETF Investing Strategies. Table of Contents Expand. Understanding Inverse ETFs. Inverse ETFs vs. Short Selling. Types of Inverse ETFs.
Real World Example. Key Takeaways An inverse ETF is an exchange traded fund ETF constructed by using various derivatives to profit from a decline in the value of an underlying benchmark. Inverse ETFs allow investors to make money when the market or the underlying index declines, but without having to sell anything short. Pros Inverse ETFs allow investors to make money when the market or the underlying index declines. Inverse ETFs can help investors hedge their investment portfolio.
There are multiple inverse ETFs for many of the major market indices. Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Table of Contents Expand. Table of Contents. Advantages of Inverse ETFs. Disadvantages of Inverse ETFs. Funds to Think About. Learn about our editorial policies. Reviewed by Thomas J. Thomas' experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning.
Learn about our Financial Review Board. Article Sources. Your Privacy Rights. Now, if you hold an inverse ETF for a short period of time, this isn't necessarily a big deal, but it's worth mentioning if you're considering an inverse ETF as opposed to simply shorting stock. Second, because of the daily rebalancing, inverse ETFs tend to underperform over long periods of time, as opposed to simply shorting a stock or index fund.
This is best illustrated with an example. Let's say that you think a hypothetical index is going to have an awful week, so you're deciding between shorting an index fund or buying an inverse ETF. When prices are dropping, the inverse ETF produces good results. But, what if the index rebounds? Let's say that on the third day, the index regains all of its losses. As you might imagine, this effect is amplified even further with 2x and 3x leveraged inverse ETFs.
Because of the daily rebalancing, inverse ETFs are best used for short-term market timing and hedging strategies, which are best left for professionals and highly experienced investors. The point is that inverse ETFs are not the same thing as shorting an index for extended periods of time, and it's a mistake to treat them as such.
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Inverse ETFs can be risky, so it pays to do your due diligence. While there are comprehensive lists of some of the best ETFs on the market, several variables should influence your decision. Your risk tolerance, your current holdings and your knowledge of current market trends all factor heavily. Shorting often requires investors to use a margin account with their brokers to buy and sell shares. If the price of a security rises above the agreed-upon margin price, the investor is liable for the cost.
Inverse ETFs can also hedge against more positive holdings in a portfolio. If an overall portfolio contains several ETFs tied to an existing index, an inverse ETF tied to the same index can provide protection if the market falls.
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