As you may have noticed, the stock market has sent investors on quite a ride already this year.
#-ad_banner-#The market lost nearly 7% in just a couple of weeks between mid-January and early February, sparking fears that a sharp correction was imminent. Those fears have turned out to be a bit premature, as the market has since nearly recouped those losses.
Hype and perception often have a more powerful effect than reality on short-term stock price movement. It may seem counterintuitive, but that's the typical pattern.
Of course, many other factors can cause stock prices to drop. Macroeconomic fears affect the broad market in a negative way, and individual stocks can get knocked down for dozens of reasons: missed earnings estimates, poor quarterly results, negative rumors, management shenanigans, even simple profit-taking.
The good news is that savvy investors can profit from this inevitable negative stock market action in three primary ways.
|SPY) can be shorted to participate in broad market sell-offs. You need to have a margin account and be approved for short selling at your broker in order to sell short.|
||DOG), Short S&P 500 (NYSE: SH) and Short MSCI Emerging Markets (NYSE: EUM). Leveraged inverse ETFs include Direxion's Daily Large Cap Bear 3X (NYSE: BGZ), Daily Real Estate Bear 3X (NYSE: DRV) and the aptly tickered Daily Health Care Bear 3X (NYSE: SICK), among many others.
Non-leveraged inverse ETFs can be bought and held just like any stock. They are ideal for catching long-term down trends in whatever the underlying instruments are.
Risks to Consider: Shorting stocks is risky because it goes against the long-term upward trend of the stock market. It requires expert timing and experience. Buying a put or using non-leveraged inverse ETFs is a much simpler way to profit from an expected sell-off. If you are able to time the selling, a triple-leveraged inverse ETF makes sense for a short-term holding period. Be prepared for heavy volatility.
Action to Take --> Practice shorting stocks in your virtual account. Most brokers have a platform that allows you to practice various investments and trades. Try a leveraged inverse ETF and buying a put in your demo account as practice before using real money. Note how the investments move relative to the underlying instrument, as well as how much margin is required to short directly. If you take the time to practice shorting, your chances of not making rookie mistakes with real money increase exponentially.
This article was originally published Oct. 21, 2013.