Shorting the Market With Inverse ETFs

If you're bearish on the market, and you think it will slump or plunge in the coming months or years, you have more investment options now than ever. With certain types of ETFs, buying shares means betting against the market or a particular sector.

One way to bet against stocks is to sell shares short. For instance, here are some of the most heavily shorted securities on the Nasdaq and NYSE:

Stock

Short Interest

Level 3 Communications (NASDAQ:LVLT)

167.5 million

Microsoft (NASDAQ:MSFT)

113.5 million

Sirius Satellite (NASDAQ:SIRI)

106 million

Charter Communications (NASDAQ:CHTR)

96.9 million

Ford (NYSE:F)

138.6 million

Countrywide Financial (NYSE:CFC)

134.4 million

Citigroup (NYSE:C)

96.6 million

Sources: Nasdaq, NYSE. Nasdaq data as of Dec. 15, 2007. NYSE data as of Dec. 31, 2007.

But instead of shorting shares directly, you can also now invest in inverse ETFs, such as the ProShares Short S&P 500. Such a security will rise in value when the market (as measured by the S&P 500 in this case) falls, and vice versa. Exchange-traded funds (ETFs) combine features of individual stocks and index funds. They can offer valuable advantages over traditional mutual funds -- read more about them in our ETF Center.

But, here's the thing ...
You should consider not shorting any investment at all, especially the broad market. Why? For one thing, you're betting against history. Over most long periods and throughout its history, the U.S. stock market has moved in one direction: up. Overall, the market goes up more than it goes down.

To bet against the market successfully, you'd have to engage in market-timing and keep your fingers crossed. For instance, consider these historical returns for the S&P 500:

Year

Return

1995

37.58%

1996

22.96%

1997

33.36%

1998

28.58%

1999

21.04%

2000

(9.11%)

2001

(11.89%)

2002

(22.10%)

2003

28.68%

Imagine yourself at the end of 1997. The market has risen far more than its annual average three years in a row. You might reasonably expect it to finally slump in 1998. But if you'd bet against the market, you would've lost nearly 30% that year. And if you had stubbornly waited for 1999 to go your way, you would've been wrong again, losing more than 20% more.

You would have made money only if you'd timed the bear market of 2000-02 perfectly. And even if you were that lucky, would you have gotten out in time, before 2003's market recovery washed away most of your profits? You would have had to time perfectly twice.

Short if you must, but do so with your eyes open.


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