Leveraged and inverse exchange traded funds (ETFs) are a useful tool in an investor’s repertoire. But short ETFs may not have been the right instrument during the fourth quarter, as one willing investor found out.
As stocks were still rallying back in October, James B. Stewart for The Wall Street Journal says that it was a prudent time to hedge some of his exposure by investing in a “short” ETF, ProShares UltraShort S&P 500 (NYSEArca: SDS), which tries to double the inverse of the S&P for a single day. The S&P 500 was at 1063. Stewart argues that the market was overdue for a correction, with stocks rising nearly 57% without any corrections of 10% or more since March. [Everything You Need to Know About Leveraged and Inverse ETFs.]
“I’m deliberately calling this an experiment, not a recommendation. I suggest that conservative investors let me be the guinea pig,” adds Stewart.
The correction didn’t materialize, and by Christmas, Stewart lost 13% while the S&P 500 gained 6%. He then thought that the market was more ripe for a correction and consequently purchased ProShares UltraShort QQQ (NYSEArca: QID), which tries to double the inverse of the Nasdaq 100 for a single day. The Nasdaq was at 2253.
On Feb. 5, the Nasdaq dropped to 2100, which produced gains of over 8% in Stewart’s QID investment. The S&P fell to 1063 the previous day. The standard 10% correction never occurred and economic indicators were coming out positive. Stewart decided to call it quits and bailed out with a modest gain in QID that offset some losses from SDS. Factoring in transaction costs, he pretty much came out even.
Stewart observes that selling short works if an investor knows when the market is overvalued and then know when a correction has run its course. The odds of knowing both are rather low.
Give him a pat on the back for conducting this experiment.
It’s great to see media people talk about their experiences and are honest about what they did and learned. The fourth quarter was a good one for the markets – it’s tough to make money shorting in a market like that. Stewart also lacked an exit strategy – something any reader of ETF Trends will recognize as a no-no! [Stop Predicting, Start Trend Following.]
For more information on inverse ETFs, visit our long-short category.
Max Chen contributed to this article.