Going short with an ETF is one of the best ways for individual investors to take a short position. Of course going short is aimed at making a profit when the market declines. There are many more ways to profit from a declining market but they all have big disadvantages compared to a short ETF.
Here I will explain the differences and I will share some thoughts about how to go short with an ETF. The way to do this deviates from other ways of going short.
Going short by borrowing or selling an ETF
In general there are 2 ways of going short with an ETF. One way is more suited for professional investors and not suited well for individual investors, especially not when you are relatively new in trading ETF’s. Another point to take in is that this particular way of going short is not easily accessible for an individual investor.
Sometimes brokers do offer this option of going short to individual investors but often it is required that you will have enough experience in investing. You will also have to hold a buffer in case you will lose money through your short position.
If you have the permission of your broker, then going short with an ETF is relatively simple. You will not have to get into the details of borrowing the ETF you want to buy. That process will be dealt with by your broker. Just as you are used in buying an ETF you will now be selling one. Eventually you will be buying back this ETF.
How professional investors go short with an ETF
Professional investors may borrow or rent long ETF’s. After borrowing or renting an ETF they immediately will sell this ETF (going short) in the hope to buy it back later for a lower price. Then they will return the borrowed or rented ETF to the lender or original owner of the ETF.
If the price of the ETF has gone down in the meanwhile (the period between borrowing/selling the ETF and buying it back) then the difference will be the profit for the investor (minus the cost of borrowing). It goes without saying that these short going parties must have enough financial buffers to cover possible losses.
Going short with an ETF for individual investors
Individual investors can also make use of ETF’s when anticipating for a declining market. Not by selling a long ETF but through buying a short ETF. There are short ETF’s available that will increase in value when the underlying assets are decreasing.
How does this work? Of course such a short ETF does not own the underlying assets. A short ETF is a synthetic ETF that is adorned with derivates such as put options, swaps etc. to be able to prosper when the assets in a particular market go down.
How such an ETF is created and what its elements are is not that important. All important is that such an ETF will react in the opposite direction of particular assets.
When the value of an investment the ETF is focused on will decline with 5% such a short ETF should rise with 5%. Always make sure before you are buying an ETF you are buying a short or long ETF, a mistake is easily being made.
Going short with an ETF or with put options?
I am not a fan of options in general. It often turns out to an all-or-nothing game. With options you always must be right on the direction a certain asset will take AND the timing when that direction will take place.
If you are wrong in 1 of the 2 you will be losing money and the chance of seeing your invested money just evaporating is great. With a short ETF you are not bound to a time limit, so you will be able to wait a little longer. The chance that you will end up empty-handed is also very small.
Going short with an ETF or with Speeders, Turbo’s etc.
Many financial institutions have come up with derivates under the name of Turbo’s, Speeders and more of the like. These are derivates with a high leverage. Through this leverage profits may be much higher or lower than the price movement of the underlying asset.
The biggest risk of the leverage is the stop loss. If losses on a Speeder or the like are amounting fast than the stop loss will get into function. When that happens you will lose much or all of your money. Unfortunately it often occurs that due to a spike in prices this stop loss will be triggered. Then you are out of the game.
Market participants sometimes willingly try to create such a spike or a short explosion of prices to be able to go through the stop losses. By looking at the order books they are able to see where many stop losses are created. Selling or buying large quantities of stocks and then flip-flopping the strategy is a daily practice of market professionals. The individual investors have to pay the price of course.
With a short ETF you are not vulnerable to these practices as no automatic stop loss is being created. But beware of new ETF products entering the market that do have leverage built in. As always is the case with leveraged products, also with leveraged short ETF’s: Beware of the risks!