5 ETFs To Protect Your Portfolio

Includes: DUG, FAZ, SPXS, TZA, VXX
by: Zacks Investment Research

China's stock market continues to see selling pressure as their economy slows. Oil's weakness not only threatens oil and gas companies with bankruptcy, but puts major economies in jeopardy of a further slowdown. Uncertainty surrounding the primaries and the presidential election is causing confusion as to what the policies of the United States will be in the future. And now, the Zika Virus is upon us, a travel and leisure nightmare that the media will run with and prevent people from traveling.

The risks and uncertainties abound are affecting global markets and will continue to do so for the foreseeable future. The situation could remedy itself, but it is more likely that the pain felt in January is not over.

If the January lows are tested and fail, there is potential for significant downside. This doesn't mean investors have to ditch their portfolios, as there are strategies that can help protect from downside. An options strategy is an ideal way to protect against loss. Inverse ETFs can also offer investors a way to profit as the market heads lower, thus protecting against their overall portfolio.

Below I picked some aggressive ETFs that would help one profit when the market goes lower. These must not be thought of as investments, but rather temporary trades. When the market eventually turns around and rallies, these instruments go down fast. The mentality one must have is to get in and out quickly as the market fluctuates.

Trading Fear

When markets get scared, they can often overreact or panic. The VIX is a fear gauge that measures how much fear there is in the markets. Traders will buy VIX instruments to hedge against panic. One of the most popular VIX instruments is the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX). This ETN provides investors with exposure to short-term VIX futures. Essentially, when the market goes down and fear increases, this ETN will go higher.

The chart below shows the last six months versus the S&P 500 and Apple (NASDAQ:AAPL). A VXX investor would benefit as Apple and the S&P 500 goes down, and lose as they come back up.

Trading Oil

Proshares UltraShort Oil & Gas (NYSEARCA:DUG) is an ETF that seeks investment results of the daily performance of the Dow Jones U.S. Oil & Gas Index. This instrument will essentially go higher when oil and gas stocks go lower, which seems to be every day lately.

For those that are nervous about their positions in oil and gas companies, there is opportunity here. DUG will head higher as shares of those companies head lower, thus offsetting losses.

If the price of oil continues lower, oil and gas companies will have difficulty being profitable anytime soon. There will undoubtedly be pressure on oil companies to either shutdown some operations or even declare bankruptcy. If this scenario pans out, the ETF will head even higher from here.

The chart below shows DUG versus Exxon Mobil (NYSE:XOM) and the S&P 500.

Trading the S&P 500

For those that want to take a more broad-based approach, they can utilize the Direxion Daily S&P 500 Bear 3x Shares (NYSEARCA:SPXS). This ETF will reflect 300% of the daily move of the S&P 500 index.

The last three months have been kind to the ETF as the selloff has pushed it 30% higher, while the S&P is down close to 10%.

Trading the Russell

Small caps have been devastated over the last three months. An investor exposed to smaller companies would have done well in the Direxion Daily Small Cap Bear 3x (NYSEARCA:TZA). The ETF is up close to 50% since the year started and if the Russell takes another leg down, it will continue on this path. This ETF, very similar to SPXS, will reflect 300% of the daily move of the Russell 2000 index.

Trading Financials

Both large and small banks have been hammered so far this year. Exposure to oil companies with potentially bad loans has investors fleeing the banks in anticipation of defaults.

If an investor is exposed to financials, it would be wise to protect against down moves with the Direxion Daily Financial Bear 3x (NYSEARCA:FAZ). This ETF will reflect 300% of the daily move of the Russell 1000 Financial Services Index.

The chart below shows FAZ versus JPMorgan (NYSE:JPM) and how a position in FAZ would offset any losses in JPM.

In Summary

When markets head lower, these ETFs and ETNs will do well. Use them to profit or soften the blow of your overall portfolio. I can't stress enough that these instruments are not investments, but rather temporary trading vehicles. They aren't for rookies and should be carefully monitored with the day to day fluctuations of the market.

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