Coping with a falling stock market

The safest method of coping with a falling stock market is to simply get out - sell the shares and invest the proceeds in some other financial instrument. For those who are confident that the market will be declining and who wish to actually profit from that foresight, the traditional strategy has been to "sell short" - sell shares one doesn't own, planning to buy them back in the future.

One practical problem is that short selling requires choosing the right stock - one might "short" XYZ only to see that particular stock rise while the rest of the market falls.

In recent years the financial community has developed "exchange-traded funds" or ETFs. Like mutual funds they are comprised of a "basket" of stocks, allowing the investor to diversify into a broad sector of the market with a single purchase. Interestingly there are ETFs that are "short" ETFs whose value rises when their component stocks fall (and vice versa).

Embedded above is the chart of an ETF with the appropriate symbol DOG, because it represents a short position of the components of the Dow-Jones Industrials. The chart shows its performance plotted against the DJIA for the past year; the mirror-image symmetry is obvious.

There are a large number of such "short" ETFs. I own some DOG, and some PSQ, which is short the NASDAQ, and some RWM, which is short the Russell 2000 index. Other ones are short specific industries (banking, real estate, gold). I'm not recommending that anyone else invest in exchange-traded funds, but it may be useful to know that such ETFs exist. If you are considering investing, be extra cautious about ETFs that are defined as "ultra-short." They move twice as much as the underlying stocks, but do so because their portfolios include time-sensitive instruments (like options), the value of which declines with time even if the share prices remain unchanged. Read this Motley Fool article and talk to an investment professional before considering such a purchase.