With an inverse ETF you are preparing for a price decline in the underlying assets of an ETF. An inverse ETF is the same as a short ETF.
An inverse ETF has higher costs
In order to create an inverse ETF you cannot simply buy the underlying assets. One has to obtain positions in short selling or derivates and that has an impact on the cost of creating an inverse ETF. So the price structure of a normal long ETF and an inverse ETF is completely different.
When to use an inverse ETF?
First and foremost, when you expect that a particular market is on the verge of declining. But you must take into account that there are some very clear reasons why you can only use inverse ETF’s in some very special circumstances. In general you can only get into an inverse ETF when a significant decline within a short period of time is to be expected.
I do not have any problems in holding long ETF’s for a considerable amount of time. But with inverse ETF’s you do not want that. The costs of an inverse ETF are high and the longer you hold this ETF the worse it gets.
There is another problem with inverse ETF’s that is a bit more difficult to explain. I will keep it as simple as possible: As an ETF is being created with derivates there will be generated some sort of leakage every time the price goes up or down.
A decline will put the price of an inverse ETF higher but whenever a small rise will follow a higher loss will be created. Whenever the market keeps on hobbling up and down you will be hurt. Through higher costs and price leakage inverse ETF’s are only effective in limited situations.
There is 1 particular advantage of an inverse ETF. When the market really goes down hard you will be able to obtain a very high return in a very short time. Buying an inverse ETF precisely on the right moment is the trick of course. And do not forget to take your profits swiftly as an upswing in prices will hurt you dearly.