Inverse Index ETFs Form Potential Double Bottom

Leading stock indexes suffered their largest one-day fall Tuesday since late August, troubled by weak factory data. The Institute for Supply Management's (ISM's) Manufacturing Purchasing Mangers' Index (PMI) for September unexpectedly fell to 47.8, down from 49.1 in July and coming in well short of economists' expectations of 50.2, to record a 10-year low. A reading below 50 indicates contraction and has investors and companies questioning how much the United States' ongoing trade dispute with China is affecting factories.

"Chinese tariffs going up are hurting our business," said one survey respondent, per Barron's. "Most of the materials are not made in the United States and made only in China," asserted another ISM member.

Traders will gain further insight into the health of the economy Friday when the U.S. Bureau of Labor Statistics (BLS) releases its September employment report that is expected to show 145,000 new jobs created last month compared to 130,000 in August. Attention then shifts to U.S.-China trade talks in Washington later this month and clues given from the Federal Reserve on the future direction of interest rates.

Those who want to position for further imminent falls in the S&P 500 Index, Dow Jones Industrial Average (DJIA), and the Nasdaq can gain short exposure to these closely watched indexes by trading the inverse exchange-traded funds (ETFs) outlined below. Each fund moves in the opposite direction to its underlying index and has recently formed a bottoming pattern. Let's go over the finer details of each ETF and discuss several swing trading opportunities.

ProShares UltraShort S&P500 ETF (SDS)

With an enormous asset base of $1.06 billion, the ProShares UltraShort S&P500 ETF (SDS) aims to deliver two times the inverse one-day return of the S&P 500 Index. The benchmark provides a measure of large-cap U.S. stock market performance. SDS turns over more than 7 million shares per day on a narrow 0.03% average spread, making it suitable for traders who want to short market bellwether names such as Microsoft Corporation (MSFT), Amazon.com, Inc. (AMZN), and Warren Buffet's Berkshire Hathaway Inc. (BRK.B). The fund charges a competitive 0.90% management fee given its use of derivate products to achieve geared returns. As of Oct. 2, 2019, SDS issues a dividend yield of 1.90% and has fallen almost 30% year to date (YTD).

As the S&P 500 Index trended higher for the first seven months of the year, SDS tracked lower but now appears to be forming a double bottom. Although a lower swing low has formed this month compared to the July trough, the relative strength index (RSI) shows a shallower most recent low, indicating bullish divergence. Those who buy the fund should think about booking profits on a move to $33, where price encounters resistance from the 200-day simple moving average (SMA) and August peak. Protect trading capital by placing a stop-loss order either beneath yesterday's low at $29.20 or underneath the September low at $28.63.

ProShares UltraShort Dow30 ETF (DXD)

The ProShares UltraShort Dow30 ETF (DXD) seeks to return two times the inverse daily performance of the Dow Jones Industrial Average Index – a blue-chip benchmark that tracks 30 large, publicly owned companies trading on the New York Stock Exchange (NYSE) and Nasdaq. DXD, which has an expense ratio of 0.95% and formed in 2006, gives traders a leveraged tactical tool. While the ETF suits those who want to bet against industrials, it also provides reasonable short exposure to the technology and financial sectors. The fund trades over 1 million shares most days and has a tight 0.04% average spread to minimize slippage. DXD has $169.53 million in assets under management (AUM), yields 1.78%, and sports a 26.39% YTD decline as of Oct. 2, 2019.

After initially dipping beneath the July swing low at $25.04, the DXD share price has reversed course to trade back above that level – indicating a possible double bottom. Bullish divergence between price and the RSI indicator also hints at waning seller momentum. Traders who take a long position should anticipate a move to around $29 – an area on the chart where price may run into resistance from a horizontal trendline and the 200-day SMA. Limit downside risk by setting stops below $25.

ProShares UltraPro Short QQQ ETF (SQQQ)

Created in 2010, the ProShares UltraPro Short QQQ ETF (SQQQ) has a mission to return three times the inverse one-day performance of the Nasdaq 100 Index. The underlying index comprises the 100 largest, most actively traded U.S companies listed on the Nasdaq that operate in industries like retail, biotechnology, industrial, technology, and health care. Due to the fund's short-term tactical purpose, its lofty 0.95% management fee won't overly affect active strategies. More importantly, a razor-thin 0.03% average spread and over $200 million in daily dollar volume liquidity keep trading costs low. As of Oct. 2, 2019, SQQQ controls $1.17 billion in net assets and is down roughly 50% so far this year. The fund yields 3.09%.

SQQQ's chart, not surprisingly, looks similar to that of the first two funds discussed. As well as positive divergence forming, a recent cross of the moving average convergence divergence (MACD) line above its signal line supports the bull case. The ETF's price closed above the 50-day SMA in Thursday's trading session to add further upside conviction. Those who enter should look to exit at $39, where price finds resistance from a horizontal line and the falling 200-day SMA. To ensure a favorable risk/reward ratio, place a stop order just below $31.