Posted by Aaron Smith on March 9, 2011 at 9:30 am

Stockbrokers.com has been taking a closer look at ETFs over the last few weeks. They have been the hottest product offering available on Wall Street for the last few months, and there are no signs of the enthusiasm for ETFs slowing down anytime soon. In this post I wanted to take a look at exactly how ETFs can be used in a down market. There is definitely a place for ETFs in a down market, so lets take a look at some of the best strategies that can help you profit even when the market is doing poorly.

Top Five Ways to Use ETFs in a Down Market

1. Effective Use of Hedges- One of the biggest benefits of an ETF overall is the ability to hedge bets inside your portfolio. It is important to remember that hedges arent necessarily designed to make money, but rather the clear reason for employing them is to limit risk. The multitude of ETFs available gives investors the ability to take a position in an asset that is typically completely non-correlated with another primary asset of yours. For example, many use an ETF that is shorting a particular index in order to reduce their exposure to the long side of the market.

2. Efficient Sector Rotation- Anyone who has been around the stock market very much at all knows that there are certain sectors which typically outperform and others who routinely underperform during a market downturn. The economy certainly moves in cycles, and the stock market closely tied to these economic cycles. As a market starts into a downward trend, purchasing healthcare or consumer staples ETFs makes quite a bit of sense. At the same time, purchasing an ETF that shorts other areas such as consumer cyclicals can be extremely profitable.

3. Diversification and Asset Allocation- An ETF is much like a mutual fund in that it is able to help you become diversified instantly. There is no free lunch in investing, but diversification is certainly a good way to limit downside risk. Asset allocation is a wise way to gain exposure to a huge variety of asset classes, which allows you to construct a portfolio that fits your personal needs. ETFs give investors exposure to asset classes which were never really available to them before, which promotes positive asset allocation methods.

4. Short the Market- One of the most obvious benefits of an ETF is that it allows an individual investor to short the market without having a margin account. There are numerous inverse ETFs which allow you to profit when a certain index or sector goes down. These inverse ETFs are a cost-effective way to profit from a downturn in the economy and the stock market as a whole.

5. Increase Exposure to Dividends- One of the more popular ways to create a safety net during a market downturn is to increase exposure to dividends. There are many high-dividend ETFs available that will allow you to purchases a variety of high-dividend yielding stocks. Alternatively, you can also invest in a fixed-income ETF, which will bring with it higher dividends. Boosting your exposure to dividends is a wise idea in a down market, and ETFs make the process simple.

Read our online broker reviews to find out more information on what broker platforms support ETF strategies for your investing needs.