Monday, November 23, 2015

The Definitive Traders Guide to Leveraged ETFs

The Definitive Traders Guide to Leveraged ETFs

 
There are many compiled lists of leveraged ETF's (L-ETF's) available on the internet, but not much information weeding out the good from the bad, what makes them tick, or how to actually trade these beasts, so here's my take.
 

Risk

 
L-ETF's don't trade like stocks. They're more volatile, and some are more volatile than others. If you're risk tolerance is low, then I suggest you steer clear of them all together. 
 
These funds are not for the inexperienced trader. If you don't know how to sell a rip to the upside in a normal index then it's unlikely you're going to have success exiting a highly volatile L-ETF.
 
Trading commodities offers more risk then trading equities, and L-ETF's that intend to track the underlying commodity... even more so. Funds which track highly volatile sectors such as gold miners, silver, crude oil, and biotech are also some of the most volatile, with intraday swings of 35% - 40%, being not all that uncommon. I say, "the more volatility the better", but you shouldn't feel like a total wuss for choosing to trade something a little less volatile - like the 3X leveraged S&P (for instance).
 

Performance 

 
Certain ETF's I call nonperformers.  They don't track the underlying index as advertised, don't perform well, or are thinly traded (illiquid). Look at a short term chart and if you see the price action leaving gaps all over the map, Its illiquid, and that means you could have trouble finding a bid when you want out. To find some good examples of illiquid funds, take a look at some short term chart views of L-ETF's you've never heard of, like the 2X EURO bear ETF - for instance.  
 
A good example of a fund that doesn't perform well is the $TVIX. It doesn't even perform as well as the underlying index so you not only get the disappointing price action, but none of the reward that comes with being leveraged.

$TVIX tracks short term $VIX futures - not the $VIX - so it's also important to know what you're trading before you trade.

Overlaying the price action on the $TVIX, and comparing it to $VIX short term futures - the $VXX only then do you get a clear understanding of why this fund should be avoided entirely.


 
 
If you thought you were going to get more bang for your buck buying the $TVIX for protection, you were sorely disappointed.
 

Charting Leveraged ETF's

 
Nearly every technical indicator normally at your disposal in and index or stock is totally absent in an L-ETF chart thanks to something called NAV (a daily rebalancing of the fund). This daily rebalancing can cause the charts to become horribly skewed over time.
 
The daily averages on L-ETF charts don't align with those on the underlying index.
 
The only useful purpose I find in charting them is that the trend lines, and patterns, can offer a good guide, when looking for good entry and exit points. See the blue line on the chart above for a good example... and in some ways charting L-ETFs is a lot like charting the $VIX. These charts don't play by the same rules.
 
Most often I'll use the technical chart on the underlying index to determine the trade. The fact that you're trading an L-ETF only means that precise entry and exit points become more critical, as these funds tend to give back all their gains within a few days/weeks after a major reversal, as we've seen over the past few weeks in shares of Direxion's 3X leveraged technology bear $TECS (for example). See the chart below.
 
If you decide to hold L-ETFs over a longer period of time, it's imperative that you exit at or near capitulation points, or you risk giving back a good percentage of your gains.
These funds aren't like an index that you can buy and hold, and forget about for a while. L-ETF's are for serious, disciplined traders.
 
That brings up the question:
 

Should leveraged ETF's be held for more than a day?

 
Some say "no", but that is not the definitive answer. While L-ETFs will bleed value over time even in a relatively flat market, and losses will compound over time - if you are fighting the trend - as long as the trend isn't against you, and you have the fortitude to stick with the trade - without being shook out on every 10% intraday move - then I say, "why not"? Just be sure to get out at, before, or soon after, the next major reversal.   
 
May the trend be with you
AA
 
This guide is not a recommendation to trade. Please read my bullet-proof disclaimer linked at the top of this blog

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