Most investors know how to make money in a rising, (or Bull), market. Just buy some stocks and watch them go up ? piece of cake. But what can we do when the unfriendly Bear market awakes from hibernation and decides to feast on our stock holdings? We discussed selling in our last article and this is certainly an option. However, investors may have reasons for not wanting to sell or, more interestingly, they may want to profit in a declining market. This is where the concepts of shorting and hedging come into play.
An investor who owns a stock is considered long the security. Another investor who thinks that stock will decline in value can borrow the stock, sell it, and buy it back later, presumably at a lower price to make a profit. This is called short selling and is a more complicated strategy than we can discuss here. However, there are a few funds out there called inverse funds that have the goal of giving the opposite return of an index. For example, an inverse fund may go up one percent for each one percent decline in the S&P 500. For extra fun, there are even dynamic inverse funds that are designed to return double the inverse of an index. An investor could buy inverse funds to protect or hedge an existing portfolio, or to profit from a falling market.
For several years, inverse funds from companies such as ProFunds and Rydex have been available to investors interested in having an investment that goes up when a stock or bond index goes down. Last week, Exchange Traded Funds from ProFunds, named Proshares, were introduced that allow investors to make inverse investments throughout the day as they would with most other stocks and ETFs. These new funds allow investors the flexibility to determine the price they are willing to pay for such a fund and place stop loss orders on inverse funds. They also allow inverse investing in accounts such as IRAs that don't always allow short selling. Keep in mind that inverse funds work both ways ? they can also go down when the index goes up.
Both Bulls and Bears can make money in the markets. With inverse funds, we don't have to let the Bears eat from our investment picnic basket.