When the market struggles, many investors bail on their investment strategy and call their brokers with only three things in mind, “Sell, sell, sell!” However, as with any sound investment, before you start shorting the market, make sure you are doing it for the right reasons.
1. Hedging Downside Portfolio RiskIf you have a substantial portfolio and want to lock in some gains or protect your downside, selling a market ETF might be the way to go. By selling a market ETF you are hedging the downside risk of your diversified assets. If the market continues to struggle, you will gain on your short ETF position to help offset some of the losses for your individual securities.
2. Hedging Downside Sector RiskIf your portfolio is more sectorized or heavily geared toward a certain industry or commodity, selling an industry ETF or a commodity ETF may be a sound strategy. Instead of shorting a market ETF, the industry or commodity ETF will give you a more focused downside hedge. For example, if you’re long a lot of oil assets, selling the OIH or USO may help offset losses with a profit on the short oil ETF position.
3. Hedging Foreign Risk
The United States is not the only country with economic turmoil. If your portfolio has exposure to regional risk (war, famine, politics, etc) then shorting a country ETF might offer the protection you need against unpredictable events. A perfect example may be to short the new Colombian ETF if you have investments related to that region.
4. Hedging DerivativesWhether you are trading ETF, Index, or even equity options, you can hedge long derivative positions with the sale of an ETF. For example, if you are long OSX (Oil Services Index) call options, then the sale of the OIH (Oil ETF that tracks the OSX) may offset some of your downside risk. Depending on the allocation of options in your portfolio, protection may be found through correlating exchange traded funds.
5. Gaining Downside Exposure
Shorting any investment is an advanced strategy due to the nature of the risk. However, in today’s economic climate it should be considered. If after thorough analysis, an investor desires some downside exposure in a certain market, sector, or region, shorting an ETF might be a successful trading strategy. By selling an ETF to accomplish this goal, a short seller not only gains his desired downside exposure, but reaps the benefits of ETFs as well.
6. Closing a Position
While this is the most obvious reason to sell an ETF, it still needs to be mentioned. If you feel you want to lock in some profits or take off a current long ETF position, then selling an ETF to close that position works as well. Due to the structure of ETFs, there are tax advantages when selling ETFs, so make sure you understand them before you make the final trade.
There are two sides to every trade. And while the “buy-side” is a very popular topic of discussion, there are those who sell ETFs, too. As long as there is good reason and strong analysis, selling an ETF might help you round out your investment portfolio and strategy. Another weapon in your arsenal.