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ETFs to Make You Rich During a Market Crash

NEW YORK (TheStreet) -- A falling market doesn't have to mean a falling portfolio value. Hedge funds were designed to hedge, or have longs and shorts in order to be market neutral. Not everyone has the desire or the ability to short stocks but that doesn't necessarily relegate your portfolio to second-tier status.

I was recently asked how someone with a self-directed Individual Retirement Account can short the market. Futures make an ideal vehicle to profit from a declining market by short futures contracts, something even an IRA account is allowed to do. But he isn't set up for futures and doesn't know the first thing about them, much less effectively execute a winning strategy.

Wall Street created a solution for investors who want to hedge against or even profit during a falling market and it's called inverse/short/bear exchange-traded funds. I often refer to the SPDR S&P 500 ETF (SPY) as a reference and usually trade oil through the United States Oil Fund (USO) ETF. Both of these commonly traded ETFs allow investors to synthetically trade futures contracts in an equity account. In other words, ETFs trade on stock exchanges, but they're designed to mimic futures and or options on futures.

Inverse ETFs are the same in concept albeit instead of creating a long position they create the opposite or a short position. Best of all, they allow a short bias while capping risk to the cost of the ETF. When the market falls and other stocks are declining, inverse ETFs rise in value.

There is a significant downside to trading ETFs to which investors should pay particular attention and the cost of carrying it. ETFs and especially inverse or leveraged ETFs decay similar to options. The decay is generated from underlying transaction costs and management fees to operate any given ETF. Some, including the SPDR S&P 500, have relatively low costs, allowing for a buy and hold strategy. But others are more trading vehicles than investments. SPXS Chart

The Direxion Daily Large Cap Bear 3X Shares (SPXS) makes an effective vehicle to short the market on any given day, but don't hold it for weeks or longer. If you do, the decay akin to an option may lose value, even if the market drops.

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