After all, this could easily just be a bear market rally. And bull markets rarely begin with a bear market rally and head straight higher.

Beware The Bear Market Trap

It makes sense to hedge against a renewed decline. Here’s why smart investors are doing so using inverse ETFs. Read on to find out what they are, how they work, and why you should consider adding one or two to your portfolio in order to protect it…

ETFs: A Safer, More Effective Way To Short The Market

Just a few years ago, investors who wanted to profit from a market/stock downturn had to borrow shares from their broker to short the asset in question. But today, betting against banks, small-cap stocks, or even entire market averages, is just one convenient ticker symbol away.

You can short the market by using an inverse exchange-traded fund (ETF).

And while I’m generally an investor who subscribes to the fact that stocks ultimately rise and produce solid, long-term gains, there are certain times when using inverse ETFs can be very appealing – particularly in the current market environment.

Exchange Traded Funds: A Brief Overview

Before we talk about the hedging advantages of inverse ETFs, let’s quickly review what ETFs are, and how they work…

• Exchange-traded funds are securities that closely resemble index funds, but are more flexible because you can buy and sell them during the day, just like common stocks.
• ETFs give investors a convenient way to purchase a broad basket of securities in a single transaction, offering the convenience of a stock along with the diversification of a mutual fund.
• From a humble start in the early 1990s, the ETF industry has exploded, particularly over the past several years. There are now over 700 ETFs, with $450 billion in assets.

And the advantages? ETFs boast several major ones over mutual funds and common stocks…

• Better diversification
• More flexibility
• Lower costs
• More liquidity
• Tax efficiency

Going Short The Smart Way With Inverse ETFs

Inverse ETFs (or short ETFs) are designed to move in the opposite direction of an underlying index. That means you profit when the benchmark tanks. The lower the underlying asset goes, the higher these funds advance.

Perfect for a bear market like this one.

Think of inverse ETFs as a type of insurance policy for your portfolio. Investing a modest amount in one of them can be a useful way to hedge against market declines, or protect your profits in certain asset classes.

And when an index or stock heads south (as we’ve seen many do with a vengeance recently), an inverse fund can help soften the blow – and in some cases, even generate enormous profits.

For example, on September 30, 2008, four days before the Dow went below 10,000, I sent a special newsflash to my ETF Authority readers identifying 14 securities that could skyrocket as the market heads south.

*Source: Bloomberg. Total returns from 9/30/08 – 3/5/09

As you can see, most of the inverse ETF have done exactly what they were designed to do in this rough market. And it doesn’t stop there…

Double Your Money with Inverse ETFs

Some ETFs can even return double the inverse of the underlying security. For example, if you buy shares of the ProShares UltraShort S&P 500 (NYSE: SDS) and the S&P 500 declines by 5%, SDS gains 10%. (Keep in mind that these funds compound daily, so if you invest for longer, the returns won’t line up exactly).

So how are these ultra-short funds able to double the inverse performance of indexes? Simple… by using leverage. The math doesn’t always work out exactly, but you can usually expect it to return double the inverse within a reasonable range.

The trade-off, however, is that these funds can be incredibly volatile – and if you’re wrong, you lose twice as much. So only consider going ultra-short if you have the stomach for it.

Why You Haven’t Missed Out on Short ETFs…

You may think you’ve missed the boat on short ETFs… but think again.

With the market coming off depressing lows, the current rally may simply be a “dead cat bounce” (which have been known to soar), as the market attempts to form a new bottom.

With this in mind, you may want to consider adding an inverse fund or two to help smooth out some of this unprecedented market volatility.

Good Investing!

Nathan Slaughter

Source: Inverse ETFs: How To Profit From The Bear Market Trap

This sucker-punch effect is even stronger as US stocks whipsaw mercilessly because of continued concerns over the housing and credit crises.

Diversifying into the 150 available exchange-traded funds – ETFs – paying double-digit yields can change that.

This from Nathan:

Why shift to income? Simply put, companies that pay dividends tend to be very stable and represent mature industries. Many do business in non-cyclical sectors like utilities and these “defensive” companies pull in steady sales, even during tough times.

And dividend-paying investments fare much better during bear markets. For example, during 2000, 2001 and 2002, the dividend-paying stocks in the S&P 500 actually rose 10.46% while others sank 33.19%. And other 10-year periods have seen dividends provide the only return for the S&P.

So you can take a chance and continue to bet against the market. Or you can collect double digit yields on investments proven to weather the storm. I know which approach I’m taking – and ETFs offer dozens of outstanding choices for income investors.

In this area, high yields are the norm, not the exception. As of the end of July 2008, 198 ETFs sported yields of more than 10%. Only 132 common stocks can say the same.

And ETFs are particularly convenient those who simply invest to pick up some consistent, extra income. Why? Because more than 500 ETFs pay distributions on a monthly basis, rather than a quarterly or yearly rate.

Score Your Own K.O. With These ETF Choices

Take a look at these three high-yielding ETFs, all of which are generating double-digit income streams:

• • One “flexible” ETF we found boasts a 12.0% yield and has an impressive track record of adjusting its strategy to capture the best gains the market has to offer in high-yield bonds, royalty trusts and other equities. That strategy – which includes buying stocks with low P/E ratios while shortening stocks with high P/E ratios – has really paid off over the last year.
  • Another appealing choice invests in real-estate investment trusts (REITs) – entities required by law to pass along 90% of their earnings to shareholders. Our favorite in this space owns a portfolio that’s double-diversified by both property type and geography. It’s an approach that is paying off with a yield of 14.8%.
  • The third ETF focuses on Asian stocks, which owns mature, dividend-paying companies such as telecoms, financials and utilities. And it pays a 21.5% yield. This fund has increased its dividend payout by 200% in the past three years.

P.S. Slaughter has put together in-depth report that will show you the three best ways to profit from ETFs right now. This special report will reveal more on how to use ETFs to capture double-digit dividend yields – including more information about some of my favorite picks – and how to profit from today’s most promising sectors and foreign markets. For more information, just click here.

Source: How to Box Clever Against a Hostile Market and Score ‘Knockout’ Yields of 21.5%