Right now, we are going through a period of a bull market. So for many, it might seem like learning how to trade during a bear market might be a waste of time. However, the market is famous for being unpredictable. And if it suddenly turns and you don’t know how to handle yourself in a bearish market, you might be in trouble. After all, it is always smart to prepare yourself for the worst. Whether you are day trading or investing, you should understand the different ways you can take advantage of market downside.
What Are Bear Funds?
Bear funds are funds that behave inversely to the market. So if the stock markets are going up, bear funds will go down. And if the markets are declining, bear funds can increase in value. For that reason, they offer a great opportunity for investors to make a profit during a downtrending market.
Of course, we should also mention that we are using a very broad term. A bear fund can be any fund that is inverse to a major index or a simple ETF.
Bonds also make up a significant percentage of bear funds. After all, bonds are a safe choice that people turn to when the market turns.
ETFs vs. Mutual Funds
The first thing a novice trader can notice about these two products is that they are very similar. On the surface, they might not be easily distinguishable at all. However, with just a bit of experience, you can notice a very important difference — ETFs trade at exchanges.
That allows investors to treat ETFs the same way they would any other stock. ETFs also have intraday liquidity which means that you can leverage day-trading strategies with them.
On the other hand, a mutual fund can only be traded once per day. Furthermore, actively trading in a mutual fund is slow and complicated. It includes having to call the mutual company and telling them what you want to do
In essence, mutual funds are better for long-term investors, while active traders prefer using ETFs.
How Do They Work?
There is no single answer that can cover the way all bear funds work. Namely, the answer depends on the product. Most of the time, the structure of bear funds allows them to benefit in a falling market. For example, index bear fund investors leverage derivative markets to create daily returns.
Those daily returns usually equal the decline of the securities the bear fund is tracking. So if an index falls by 1.5% during a single day, the bear fund that is tracking it will rise by 1.5%.
But that is not the only way bear funds work. Another common form of bear funds comes in the shape of inverse leveraged funds. These funds don’t move the same distance as the index they are tracking. Instead, they can net a trader significantly bigger profits. But they can also lead to significant losses as well. A two-times leveraged fund can double the movement of an index. So, for example, if an index moves by 2%, the bear fund will move by 4% in the opposite direction.
Risks and Benefits of Investing in Bear Funds
Investing in bear funds can be risky. In short term, they can be very valuable. However, they rely on bear markets to net a profit. And a bear market usually tends to be volatile.
With proper timing, investors who decide to use bear funds can pocket a lot of money. However, the volatility of the bear market also means that the losses can be significant as well.
Another benefit of using bear funds is the fact that their inverse nature makes them ideal for hedges. Moreover, instead of having to reach out to a broker to try and profit from a downward trend by short-selling, you can simply invest in a bear fund instead.
However, as you can notice, every benefit comes with a flaw. The short duration of bear markets means that you have to be ready to exit a position before it becomes a disastrous investment for your portfolio.
Thinking of the short term is usually the way to go with bear funds. Sometimes, that short-term can last for up to a month or few, but more often than not, a bear fund stops being profitable after a few weeks.
In the End
If you are looking to hedge a long position in the market, you can do so by investing in bear funds. They are useful and have a potential to net a substantial profit. However, in the long term, they tend to underperform. In the end, investing in bear funds is all about awareness and reacting to the twists and turns of the market.