Thinking About a Short or Inverse ETF? Read This First

As the stock market tumbles, many individual stocks are falling with it. That makes short and inverse exchange-traded funds (ETFs) more tempting, as they seem to promise one simple trade to profit while stocks are falling across the board. Unfortunately, it's not that simple. Inverse ETFs can be helpful tools, but you have to use them correctly.

Inverse ETFs are designed to rise when their target benchmarks fall. The fund managers typically use short positions and options to achieve this. For example, the ProShares Short S&P 500 ETF (NYSEMKT: SH) is designed to produce opposite returns to the S&P 500 index each day.

That's all pretty straightforward at face value, but there are some important details to consider. These funds are designed to invert an index or benchmark's single-day performance, not the long-term returns. Short ETFs are typically rebalanced each day. As a result, an inverse ETF's performance can diverge from its benchmark over weeks and months.

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Source Fool.com