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

Rick Pendergraft says no bailout can immediately solve the problems in the housing market. And all indicators suggest these will run well into 2009 at least.

Rick says your portfolio should be all about playing safe for now. He recommends eight inverse ETF plays to hedge against this downside risk.

This from Investor’s Daily Edge:

I can understand the fixation on the bailout, but other economic reports are getting lost as a result.

Last Thursday was a day that the mass distraction was working to its full capabilities. Investors chose to ignore all economic data in order to focus on the progress of Congress.

In case you missed it, durable goods orders for August were down 4.5 percent from July (I guess the stimulus checks ran out), initial jobless claims jumped to 493,000 (the highest figure in seven years), new home sales dropped to a 17-year low and home sale prices dropped 11.8 percent (the largest drop on record).

But the bailout is going to solve all of this and it will do it immediately, right?

I don’t think so. Companies are not going to start borrowing tomorrow and banks are not going to start throwing money at people all of the sudden.

Granted the bailout should help stabilize things and keep us from going into an all out meltdown, but it is not going to fix everything and it isn’t going to do it immediately.

I hate to sound like such a doom and gloomer, but if it’s cloudy outside, I am not going to tell you that it’s sunny and hope that you don’t notice.

Last Wednesday, we had a company wide meeting and we were all asked to state what our goals were for each day. My answer was in two parts: my goal is to make my readers money or educate them. It’s that simple.

Having said this, should a bailout agreement get reached before you receive my article this morning (they are feverishly working on it), expect a rally when an agreement is reached and it is approved in congress. But don’t go buying into the rally.

I think this is going to be another case of buy the rumor and sell the news. Any agreement that is reached will cast a sense of relief for the financial sector, without a doubt. However, it isn’t going to solve the underlying problems with our economy.

We will continue to see job loss in the coming months (the September employment numbers will be released on Friday), consumers will still struggle to keep up with their obligations and the housing market will continue to slip for the foreseeable future.

I have expressed in IDE many times that I don’t think the economy turns around until the housing market turns around. Based on the housing reports last week and the inventory of homes on the market, housing isn’t going to rebound in 2008. My guess is that it will be at least the second quarter of 2009 before we see housing start to stabilize, and then the second half of the year may produce an actual upswing in housing.

Until the economy starts showing some improving vital signs, your best bet with your portfolio is to play it safe. Keep part of your portfolio in cash and use part of it to play the downside.

A few weeks ago I mentioned inverse ETFs as a way to play the downside. I received an email from Joan K. asking for a list of inverse ETFs, so for Joan and all of your benefit here is a short list.

ProShares Ultrashort QQQQ-QID
ProShares Ultrashort Dow 30- DXD
ProShares Ultrashort S&P 500- SDS
ProShares Ultrashort Russell 2000- TWM
ProShares Ultrashort Semiconductors- SSG
ProShares Ultrashort Financials- SKF
ProShares Ultrashort Basic Materials- SMN
ProShares Ultrashort Technology- REW

If you want to hedge your portfolio appropriately, you can buy the inverse ETF that most accurately depicts the rest of your portfolio. For instance, if you own numerous technology stocks, to hedge your portfolio you can buy the QID or the REW. The REW is the leveraged inverse technology fund, but the QID should also gain if technology stocks continue to drop.

Source: Once Again, Wall Street Gets Distracted