What is shorting ETFs (Exchange Traded Fund)?

Exchange traded funds (ETFs) are a sort of umbrellas which can hold a large number of securities within them but are bit more complex than mutual funds. They are similar to the stocks which can be traded on the stock market during the course the trading day. Many times the investor and traders want to sell ETF’s without first owning them because they thing the market price will go down. This is called shorting ETFs.

How does Shorting ETFs take place?

Shorting ETFs refers to the selling of a fund by the investor when he foresees a downfall in the price of the exchange traded fund. Shorting ETFs is a method of protecting the investor’s portfolio. If an investor is expecting a downfall in the price of the security lying behind his funds, he will sell the fund without owning it in the first place. This can be done through a broker who will lend the ETF to the investor to sell. When the investor thinks the ETF has fallen enough, he will often buy back the ETF and return the borrowed shares to the broker. The profit the investor makes is determined by calculating the difference between the price he sold the ETF and the price he bought back the ETF. It is very important to note that the risk associated with shorting ETFs is also considerable. If the expectations of the investor do not meet reality and the market goes up instead of going down, this will cause the investor to lose money, instead of making a profit.

Reasons for shorting ETFs

Most ETF’s are composed of a large number of stocks that much the underlying index. This is one of the features of exchange traded funds that give investors confidence to go towards shorting ETFs. One of the beauties of shorting Exchange Traded Funds is that they are exempted from the uptick rule which was designed by the Securities Exchange Commission to keep a watch on the short selling of stocks. This allows investors to think broad and attain handsome profits from shorting ETFs and reduce the risks associated with their portfolio.

Is shorting ETFs beneficial?

Exchange traded funds are good investment vehicles and the method of shorting exchange traded funds adds to the advantages the investors get out of them. ETFs are much more flexible than mutual funds and provide tax benefits to the investors as well. Shorting ETFs is much more beneficial over shorting of individual stocks as the former, being a collection of stocks, as safety built into it because if the market was to go down an ETF would not go down as much as individual stocks because of its composite nature.

It is very important for the investor to make a detailed study of the underlying stocks and companies on which the exchange traded funds are composed. The time of shorting ETFs is very important and if the plan is not timed correctly, it can open doors for higher losses for the investor. Shorting ETFs is thus not meant for new inexperienced or amateur investors as it requires a great deal of timing and market understanding. Still it must be preferred over shorting stocks as it is much less risky.

The right Mindset for shorting ETFs

To get through the hurdles of shorting exchange traded funds is a big hurdle for small investors who want to put in little amounts of money into the market. If the investor is thorough with his research, understands the market conditions and can forecast the fluctuations well, shorting ETFs can prove to be extremely financially rewarding.

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