How to Use ETF Hedge Fund Strategies

Hedge funds are an elusive form of investing that is often misunderstood by the general public. Historically, people who solicited large sums of money from already rich people and exploited the market to make even more money ran hedge funds. Since the funding was private, these people could avoid many of the rules and regulations that other investors were forced to follow. There are some ways to use hedge fund strategies with exchange-traded funds (ETFs).

Difficulty: Moderately Easy

Instructions

1. Shift some of your investments to short-term ETFs. Hedge fund strategies don't look for long-term growth, and they try to predict how a stock will behave in 2 days rather than 2 years.

2. Short sell ETFs by borrowing ETFs from your broker and selling them. You will have to give back an equal number of the shares that you borrowed, so you must purchase them again. Short selling assumes that you know a stock will drop in price, so you buy it at a lower price, reimburse your broker and keep the difference in profit.

3. Negotiate for futures contracts. You can use this hedge fund strategy to reduce the risk of your investment to nothing. You sell a futures contract on your ETFs that says you'll sell them at a determined time for a determined price, which is independent of the actual market value.

4. Set up derivatives options with another party, possibly a broker. This contract will give the other party the choice to buy your ETFs at a certain price during an agreed upon time period. For an option to work in your favor, the actual value of the ETF will have to drop to less than the price agreed on in the option.

5. Use leverage to increase your ETF investment opportunities. Leverage is basically debt or a loan that is taken on to increase your available funds for ETF investment. Leverage can increase your return on a short-term ETF investment, but it can also hurt you financially if the investment turns against you.

Tips & Warnings

• Most hedge funds use a combination of several strategies to minimize risk and increase potential profits at the same time. For example, you could use leverage to help finance the short selling of foreign ETFs while buying currency futures to protect your returns from a bad exchange rate.
• Options and futures sound similar, but the former does not obligate you to sell or buy anything. Also, options have costs associated with them to protect the seller from losses.
• There are laws and regulations that limit short selling to prevent continual damage to the market.