What Are Inverse ETFs?
Inverse ETFs are exchange-traded funds that structure their portfolios to take advantage of downward moves of a given index, asset class, or type of security. They generally have some combination of actual short positions, put options, and derivatives.
An inverse ETF is designed to help speculators conveniently be bearish or short an investment. In other words, this ETF should act the opposite of the underlying investment. For example, if the ABC Oil ETF is intended to track oil’s price movement up or down, then the ABC Oil Inverse ETF will attempt to have the opposite or inverse price movement. You can buy an inverse ETF in the same way you’d buy a stock or a regular security.
Short and bear are the words most often used to indicate that an ETF is an inverse ETF. Although a regular ETF may be called XYZ ETF, XYZ Long ETF, or XYZ Bull ETF, an inverse ETF will most likely be called the XYZ Short ETF or XYZ Bear ETF.
Additionally, the language of speculators will make the inverse status clear. When you hear someone say, “Richard is bearish on the QRS sector, so he acquired the QRS Bear ETF,” you can be sure that having “Bear” in the name makes it clear that the expectation or goal of the ETF is a decrease in the value of the underlying asset or index.
Inverse ETFs also come in a turbo-charged form. You’ll notice inverse ETFs with words like ultra and references to “2X” or “double short” and also “3X” or “triple short.” These terms refer to inverse ETFs that intend to double or triple the potential price move.
Before you try out an inverse ETF, go to a popular financial website and create a chart to see how both an investment and its inverse ETF have performed during a given period, such as a month or a year. (Many sites let you chart investments for free.) This chart will give you an idea of how both of them diverge (or go in opposing directions). Then start simulated trading, and record the starting points of the investment you’re tracking and the inverse ETF. Track their movements over a week, 2 weeks, a month, and, say, a quarter (3 months). Then ask yourself whether you would have made money or lost money had you actually traded. Why or why not?
This exercise, called backtesting, is recommended as a way to test how well an inverse ETF has acted in real market conditions. You can see real-world results to help you make more predictable trades. Many professionals do this.