Inverse ETFs are investments which are traded in a public stock exchange like normal ETFs. While ETFs sell stocks, follow and move along the sensex index, Inverse ETF do the opposite, they follow the index on the opposite side which means they go on the reverse side of index movement.
Inverse ETFs play short by investing in the falling market where in the investor books profits against a bear market which is the opposite of bull market. Hence these funds are also called Short ETF funds or Bear ETFs.
The working of an inverse ETF is different from a normal ETF. For example, an inverse fund PSQ ETF, traces the movement of daily percentage variation which is opposite of PSQ. If the PSQ rises by 2 percent, the inverse ETF falls by 2 percent and if the PSQ falls by 3 %, the ETF will accordingly rises by 3%. Thus the ETF value decreases when the Fund index increases and increases with the fall in market. The investor short sells his shares when the market falls and books profit.
These funds operate through investment mechanisms like derivatives trading, forward booking, future contracts, short selling and other similar methods. Many of the inverse ETFs work with multiplier effect, against an index percentage change they move in the opposite direction of the market in multiple proportions. If for e.g. The PSQ index records a upward movement by 2%, an ETF working at 2x multiplier moves down by 4 % against the index. Some of the common Inverse ETFs are 1x, 1.5 x and 2x multiplier leveraged funds.
Inverse ETFs are traded in sensex stock exchanges like Nasdaq or Russel 2000. Many Financial Institutions offer Funds in various categories. Some ETFs are sector specific and focus on sectors like Energy, Oil, and Commodities etc. Investing in such sector specific portfolios calls for very good understanding of the market dynamics and the investor needs to be familiar with the sector and be able to predict the futuristic trends accurately.
A few of the ETFs (Mutual Funds) traded in the American and Canadian markets are: Direxion Funds, Pro Funds, Rydex Investments, Inverse Sector ETFs, and Inverse Commodities ETNs & Inverse Currency ETNs.
Some of the currencies traded called popularly as ETNs are: UDN – Double inverse US dollar, EUO – ProShares double inverse Euro & DRR – Van Eck Double inverse Euro.
People invest in ETFs for various reasons. Such investors are normally very informed investors who understand the mechanisms of market trends. The informed investors look for booking profits not only when market index rises but also use the opportunity to make profits in a falling market. They often watch the markets and sectors closely to estimate a near future fall of a particular market and move in to make use of the falling trends.
Sometimes investors look to cut short their losses in the falling market by short selling and closing their investment exposure. In such transactions the investor may not make a profit, but has reduced the extent of his losses. Such investors use inverse ETFs to hedge their portfolios against falling markets and use these investment mechanisms as a back up plan.
Inverse ETFs allow trading without any trading account or a margin account. This gives the freedom to an investor to actively invest in market at short notice and without having to lock up extra funds.