3 Oversold ETFs for Traders

The surge in stocks last week has led to pullbacks in many of the leveraged inverse exchange-traded funds that had helped traders make so much money over the past several weeks. Is another opportunity in these ETFs setting up?

I last wrote about leverage inverse ETFs several days ago, as many of these names had just begun to pullback. The beauty of leveraged inverse, or leveraged "bear," funds is two-fold.

First, because they are leveraged, traders can get a 2-to-1 bang for their buck without having to use margin (of course, for traders who use margin, the leverage can increase to 4 to 1 or more). This means that many trading strategies that traders have used successfully with high volatility stocks can be effective with the ETFs whose 2-to-1 leverage helps make up for the relative lack of volatility in exchange-traded funds compared to stocks.

The second plus with leveraged inverse funds is that they allow traders to bet against a market without having to sell stocks short or sell exchange-traded funds short. While the removal of the uptick rule has made short selling easier for the average trader, the process of selling short--establishing margin, borrowing assets, etc.--remains more involved than the process of buying stocks or ETFs. This makes inverse ETFs a much easier, much clearer path to taking a bearish position on a sector, investing style or market compared to short sales.

Let's take a look at the three leveraged inverse exchange-traded funds that appeared on our screens as of the Monday close. All three of these ETFs have earned Short Term PowerRatings of 8. Our research into short term stock price behavior, research that examined millions of short term stock trades between 1995 and 2007, tells us that stocks with Short Term PowerRatings of 8 have outperformed the average stock by a margin of more than 8 to 1 over the next five days.

The first exchange-traded fund is the ProShares UltraShort S&P 500 Fund (SDS | Quote | Chart | News | PowerRating). This ETF is geared to perform twice the inverse of the S&P 500.

The S&P 500, as you probably know, is home to some of the biggest and best-known companies in the United States. For traders looking to bet against the fortunes of the stock market as a whole--or simply to hedge a portfolio of large-cap stocks--the SDS is one of a number of excellent vehicles.

If you want to wager against some of the more high-powered technology names--then one of your options should probably be the ProShares UltraShort QQQ Fund (QID | Quote | Chart | News | PowerRating). This fund, as its name suggests, looks to perform two times the inverse of the QQQ, the tracking fund of the Nasdaq 100.

The Nasdaq 100 is home to some of the biggest technology companies in the stock market, including companies like Microsoft (MSFT | Quote | Chart | News | PowerRating), Apple (AAPL | Quote | Chart | News | PowerRating) and Google (GOOG | Quote | Chart | News | PowerRating). If you own these stocks and think you need to hedge against a potential downturn, the QID may be as good a choice as any--and certainly less cumbersome than buying puts as a hedge.

And for those traders who simply believe that technology stocks have further downside ahead of them, the QID is a suitable, highly liquid vehicle for expressing that opinion.

Last but not least is a somewhat more esoteric exchange-traded fund, the ProShares UltraShort Midcap 400 Fund (MZZ | Quote | Chart | News | PowerRating). This fund focuses not on the biggest stocks in the market, nor on the smallest, but instead on that mid-range of stocks that money managers in recent years have found to have many of the positives of small cap stocks without many of the negatives that accompany that group.

Again, as a leveraged inverse fund, MZZ looks to achieve gains consistent with twice the inverse performance of the Midcap 400.

What stocks can be found in the Midcap 400? Some of the funds larger holdings include stocks like Legg Mason (LM | Quote | Chart | News | PowerRating), SanDisk Corporation (SNDK | Quote | Chart | News | PowerRating), and Peabody Energy (BTU | Quote | Chart | News | PowerRating).

If you are not familiar with the world of leveraged, inverse exchange-traded funds, then consider getting a copy of our special, Free Report, "How to Double, Triple or Even Quadruple Your Returns Using ETFs". This report will help explain what leveraged and leveraged, inverse exchange-traded funds are, what they consist of and how traders are increasingly turning to them as a way to boost their returns and increase their profitability. Click here to get your copy today.

David Penn is Senior Editor at TradingMarkets.com.