As the U.S. government shutdown and the looming debate over the debt ceiling continue to cast a long shadow over an otherwise prosperous market, concerns of a market downturn continue to rise to the surface. For investors, managing an investment portfolio comes down to knowing how to profit in both the up and down markets. This requires a broad understanding of the tools available for such navigation.

Is The Market Ready To Fall?

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As of October 7, the market appears ready to test a new level of support. The S&P 500, as represented by the SPDR S&P 500 (NYSEARCA:SPY ), has been channeling higher over the past few months. Yet it now faces a bottom support level even as Congress continues to squabble over the debt ceiling. Should an agreement fail to be met, the effect on the market will undoubtedly be negative. At the same time, it is worth noting the Volatility S&P 500 (VIX) has been steadily climbing higher as it last closed at 19.41. The index appears ready to break into new highs having tested its support around 12.00.

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^VIX data by YCharts

Shorting The Market

For these reasons it remains ideal to prepare for the worst. The Russell 2000 is a popular stock index which is used to track companies with small market capitalizations. Made up of the bottom 2,000 stocks of the Russell 3000 Index, the Russell 2000 stands as a diversified portfolio of small companies. As such small companies tend to experience higher volatility in light of market-changing events, investments that track this index are often subject to a similar effect.

One such ETF magnifying the volatility of this index is the Direxion Daily Small Cap Bull 3x Shares ETF (NYSEARCA:TNA ). The fund seeks daily investment results, before fees and expenses, of 300% of the performance of the Russell 2000 index. While advantageous in a bull market, the ETF pulls back with more force in a bear market due to the effects of this multiplier.

By entering into a short position in TNA, investors convinced of a market downturn can effectively leverage their position to exploit sharper declines. Because it is focused on the Russell 2000, a short position in TNA retains the strong correlation to the overall market direction (compared to shorting a particular stock) while utilizing the multiplier of the ETF and the increased volatility of a small-cap index.

Such a short position in TNA maximizes the risk potential of an investment and remains ideal only for those looking to maximize their profit possibility in a market downturn. There is unlimited loss risk in any short position, but this is only compounded by the ETF multiplier should the market not act according to the investor’s expectations.

One such hedging method to protect against this short position would be to open a long position in the iShares Russell 2000 Index ETF (NYSEARCA:IWM ). This popular investment seeks to track the Russell 2000 itself. Seen in the chart below, we see that the correlation between the two ETFs remains relatively consistent to the intended multiplier. By going long IWM as a hedge, investors can also rely upon a position not subject to leverage or the effects of contango (the decaying price effect due to time loss). This provides a ready position that can be safely held over the long-term after the TNA position is closed.

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TNA data by YCharts

Final Thoughts

By using a long position in IWM as a hedge against a short position in TNA, this can effectively set up a model that can accurately reflect an investor’s risk tolerance in a bear market. Determining how many shares to buy in IWM can be akin to how one would utilize a car while driving downhill. If the market continues to fall, investors can decide whether to take the foot off the accelerator (close the short TNA position) or apply the brakes (buy the long IWM position as a hedge). This provides two separate investments that work in tandem with the other. Above all, the model provides the necessary control investors desire when looking to cautiously invest in a bear market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.