In rough markets, the ability to go short or long either 200% or 300% of an index’s daily value can prove to be a useful trading tool. But these types of funds should be used with caution, as with any investment, since they amplify market movements. In these times of higher volatility, that means big swings one way or the other than can catch an investor off guard if they aren’t paying attention.

It seems like for most of this year, long and short funds have been perched at the top in terms of daily performance. They can also give a quick snapshot of what sectors are feeling pain and how the markets are doing in general. Seeing a cluster of shorts sitting at the top of a list of funds ranked by daily, weekly or monthly returns tells you that the markets are hurting right now.

For the last five trading days, among the funds at the top are:

• Rydex Inverse 2x S&P Select Sector Financial (RFN)
• ProShares UltraShort Financials (SKF)
• ProShares UltraShort Real Estate (SRS)
• ProShares UltraShort SmallCap 600 (SDD)
• Rydex Inverse 2x Russell 2000 (RRZ)

Not all funds are right for every investor, so investors need to decide what is right and what works for them while using caution, and supplementing that with some education and research. If you think these funds might be right for you, do a gut check and make sure your risk profile fits.

We advocate sticking to a strategy of considering only those funds that are above their long-term trend lines (the 200-day moving average). Once they fall below that mark or 8% off the high, it’s time to let it go.

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

Sam Patel for TheStreet reports that the top ETF performers for the third quarter were the inverse, or short, ETFs. These funds are designed to go up whenever the markets go down.

As with any investment, it’s wise to be aware of the risks. While these funds do present opportunities in down markets, investors need to use them with caution. While market whipsaws in a negative direction can bring good news, those in a positive direction can cause quick losses.

Some of the top short ETFs for the third quarter and their performance numbers include:

• UltraShort Basic Materials (SMN), up 85.3%
• PowerShares DB Oil 2X Short (DTO), up 76.5%
• PowerShares DB Commodity Double Short (DEE), up 70.4%
• PowerShares DB AGR Double Short (AGA), up 67.9%

Wall Street’s most recent week has also seen some stunning losses that have benefitted these funds. Among the top short ETFs this week, shown with a one-week performance chart, include:

• Rydex Inverse 2x S&P Select Sector Energy (REC), up 69.2% (black line)
• ProShares UltraShort Telecommunications (TLL), up 79% (green line)

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

These types of funds are merely two years old, and the timing of their market debut was perfect.

ProFunds originated these funds back in 1997, when bear market index funds were created for investment professionals, reports Billy Fisher for TheStreet. The first short ETFs were launched in the summer of 2006, and those funds were:

• Short QQQ ProShares Fund (PSQ)
• Short S&P 500 ProShares Fund (SH)
• Short Dow 30 ProShares Fund (DOG)
• Short Midcap 400 ProShares Fund (MYY)

Since then, the number of not only these ETFs, but providers offering them and asset classes they cover, has expanded to include such funds as:

• PowerShares DB Agriculture Double Short (AGA)
• PowerShares DB Gold Short (DGZ)
  
• Rydex Inverse 2x Russell 2000 (RRZ)
• Rydex Inverse 2x S&P Select Sector Financial (RFN)
• Market Vectors Double Short Euro (DRR)

ETF investors no longer have to wait out on the sidelines while market turbulence dominates. Instead, they can benefit from both the ups and downs of markets while hedging their short-term risk. By subtracting the short-term risk, inverse ETFs have given investors the option to expand one’s holding period in a long position quite comfortably.

We caution investors, however, to be aware of the risks of these funds and to understand what they’re getting into. Because they can be especially susceptible to whipsaws in the marketplace, sticking to your sell strategy is key.

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

Yesterday, financials continued to decline as Merrill Lynch (MER) shares dropped almost 10%, bringing the entire sector lower amid fears over credit quality and the housing sector.

Today, things are looking a little brighter, as most ETFs in the sector are up once again. For example, the Financial Select Sector SPDR (XLF) is up by more than 4% midday.

Over the weekend, U.S. lawmakers passed a rescue package targeted to help struggling homeowners and boost the confidence in mortgage giants Fannie Mae and Freddie Mac. However, as Elinor Comlay reports for Reuters, this bill will take time to go into effect and will more than likely not cure the housing crisis because of the many difficulties financials are facing.

Despite Congress passing this rescue package for Fannie Mae and Freddie Mac, the rest of the industry will be left fighting for themselves as the grim outlook for consumers and the economy persists. In talking with CNBC, Kathy Boyle expresses her main concern as simply being that we are not finished yet. She explains, “Wall Street would like to think that the worst is over , but we’ve been saying that for a while.”

As the current state of affairs in financials is ever-changing, some ETFs to cover both ups and downs a may be:

• Rydex Inverse 2x S&P Select Sector Financial (RFN), launched July 18
• UltraShort Financials ProShares (SKF), up 33.1% year-to-date
• Ultra Financials ProShares (UYG), down 50% year-to-date

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.