Shorting Chinese Stocks with the FXP ETF

Chinese stocks have ended down six days out of the last ten. Whenever that happens there is inevitably talk that we've entered a "bear market" - that stocks are on a downward trend.

Investors in Chinese equities are particularly sensitive to such speculation because many of them have seen their holdings skyrocket since the end of 2005. Chinese stocks as a whole have risen five hundred percent over the last two years, and more and more analysts are saying a market correction is overdue. Investors know this party can't last forever.

I'm not an investment expert, so I can't tell you whether this is true, but let's assume for argument's sake that we have, in fact, entered a bear market in Chinese stocks. What should you, as an investor, do?

The answer is simple. You should short Chinese stocks - bet against them - and there's an easy way to do this: buy shares of a bear market ETF. Exchange-traded funds, or ETFs, are funds that can be bought and sold like stocks. They differ from stocks in that they tend to focus on groups of companies, sectors or markets as a whole, rather than on individual firms. They're also usually more expensive to trade because they charge fees on top of trading commissions when you buy and sell them. But they've opened up a whole new world of money-making possibilities to investors, including the ability to short stocks from a single market economy, like China.

The bear market ETF that's used to short Chinese stocks is called the ProShares UltraShort FTSE/Xinhua China 25; its ticker symbol is FXP and it's from the ProFunds family of funds. FXP made its debut on Nov. 8, 2007, and has gained quickly in popularity. Today, for example, it was traded more than 1.8 million times on the stock market, according to data from Yahoo! Finance.

The "ultra" in the name of this ETF indicates it produces turbo-charged returns: it rises two dollars in value for every dollar lost by the FTSE/Xinhua China 25 Index. Of course, the reverse can happen too; it'll fall two dollars for every dollar rise in the same index. The FTSE/Xinhua China 25 Index tracks the 25 largest and most liquid Chinese stocks listed and traded on the Hong Kong Stock Exchange.

The top ten companies tracked by this index are the following: China Mobile, Ltd., China Life Insurance Co., Ltd., PetroChina Co., Ltd., Industrial & Commercial Bank of China, China Construction Bank Corp., Ping An Insurance Group Co. of China Ltd., China Shenhua Energy Co., Ltd., CNOOC Ltd. (an oil company), China Telecom Corp., Ltd., China Merchants Bank Co., Ltd.

FXP, in terms of performance, attempts to be the inverse (doubled) of FXI, the iShares FTSE/Xinhua China 25 Index Fund, which is part of the Barclays Global Fund Advisors family of funds. This is a regular, non-bear-market ETF. I have found that, in practice, FXP does not precisely perform the opposite (times two) of FXI, but it comes pretty close. Today, for example, FXI was up 5.66% while FXP was down 9.43%, per Yahoo! Finance.

If you're like me and the wild swings of an "ultra" fund make you nervous - and these swings can be huge in today's volatile market environment - you may want to "hedge" your bear market FXP with FXI. For example, invest an equal amount in each. With such a portfolio, you would still be betting that the market would go down, but you wouldn't lose as much if stocks temporarily moved in the opposite direction. (The downside is that you wouldn't earn as much either, if the stock market does, indeed, go down.) Two other China-focused ETFs to consider as hedges against FXP are PGJ (Golden Dragon Halter USX China Portfolio Fund) and GXC (SPDR S&P China ETF).

The FXP exchange-traded fund charges a management fee of 0.75% and has an expense ratio of 0.95%. These are charges you will pay in addition to regular trading commissions whenever you buy or sell the ETF.

NOTE: You invest at your own risk. The author and this website cannot be held responsible for investment losses incurred by readers of this article. (Be careful. You could lose your shirt.)