With the equities market exhibiting greater bouts of volatility, exchange traded fund investors can utilize inverse or bearish strategies to help protect against the turns and limit the negative effects of any further drawdowns.
On a recent webcast, Managing Market Pullbacks with Inverse ETFs, Sylvia Jablonski, Managing Director and Head of the Capital Markets & Institutional Strategy Team at Direxion, explained that inverse ETFs typically replicate the inverse returns of a benchmark on a daily basis, allowing investors to easily gain short or bearish exposure to various areas of the market.
Jablonski pointed out that traders have typically used inverse ETFs to maintain momentum strategies, capitalize on short-term opportunities or hedge against unforeseen risks.
“Inverse ETFs can provide an easy means of short-term hedging for long-term investors,” Jablonski said.
However, potential investors should be aware of the risks associated with these inverse products. Specifically, Jablonski reminded advisors that these ETFs rebalance on a daily basis, so the inverse funds may not perfectly reflect their intended strategies over long periods due to compounding issues as a result of the daily rebalancing.
In Trending markets that move consistently in a single direction, compounding may benefit inverse ETFs. However, in more volatile markets when securities experience greater oscillations, an inverse ETF may underperform its intended -1x, -2x or -3x multiples compared to a benchmark..
Related: VIX, Bearish S&P 500 ETFs to Hedge Uncertainty
Jablonski also pointed to a number inverse ETF strategies that could help traders hedge against potential market risks ahead. For instance, the Direxion Daily CSI 300 China A Share Bear 1x Shares (NYSEArca: CHAD), Direxion Daily S&P Biotech Bear 1X Shares (NYSEArca: LABS), Direxion Daily Financial Bear 1x Shares (NYSEArca: FAZZ), Direxion Daily Energy Bear 1x Shares (NYSEArca: ERYY), Direxion Dialy Technology Bear 1x Shares (NYSEArca: TECZ) and Direxion Daily S&P 500 Bear 1x Shares ETF (NYSEArca: SPDN) provide inverse or -100% exposure to some of the more volatile areas this year.
On a survey of financial advisors who attended the webcast, 26.9% of respondents pointed to oil & gas as the area that could offer the most tactical opportunities in the next 6 months, followed by 16.4% pointing to Europe, 15.8% looking to gold related and 14.0% watching financials.
[related_stories]Tom Dorsey, Co-Founder of Dorsey, Wright & Associates, pointed to the relative strength technical indicator to help financial advisor and investors to gauge a securities’ momentum in the market.
“This reading is plotted on a point and figure chart, which then tells us whether we can expect that stock or ETF to outperform or outperform the base index,” Dorsey said.
Relative strength is a type of momentum investment technique that compares the performance of a security to that of the overall market. The indicator calculates which investments are the strongest performers compared to the overall market and suggests further investments for purchase.
Related: Navigating Risks of Leveraged, Inverse ETF Play
Along with the momentum indicator, investors can also utilize other trend following techniques. Jablonski pointed to a simple trend following strategy around the 200-day moving average indicator. For example, if the S&P 500 is trading above its 200-day, go long the S&P 500. On the other hand, if the index dips below its 200-day, go short or inverse S&P 500.
Financial advisors who are interested in learning more about hedging strategies for a volatile market ahead can watch the webcast here on demand.