Doubling One's Money in 7 1/2 Months with Triple Leveraged ETFs?

For many who bucked convention, prognosticators and naysayers, the unrealized profits on a number of triple leveraged ETFs are extraordinary. For example, Direxion Daily Technology Bull 3x (TYH) is up 94% through 7/20/09.

Perhaps the most amazing part is in the way that investors may have achieved the gains; that is, a buy-n-holder of a daily leveraged fund is extremely unlikely to see anywhere near the 2x or 3x promise due to the way that compounding works. (Review "Buy-N-Holders Beware... These Are For Active Traders.")

And yet... the gains are real. There they are on the YTD chart.

Still, with volume hitting new records in July, one has to wonder whether the desire for leverage in tech won't come back to haunt. In fact, the same type of enthusiasm is occurring for emerging market investments such as Direxion Daily Emerging Market 3x (EDC). This ETF has garnered 84% through 7/20/09.

I guess the question that most folks would have is... if you believe in the emerging market growth story... why wouldn't you buy-n-hold these ETFs? Isn't 84% better than the Vanguard Emerging Markets (VWO) 43% YTD?

Well yes... and no. If a daily 3x fund works well, as it has here, you may get 2x the upside over time. In fact, shouldn't the 3x fund have achieved 130%? In effect, you may be taking 3x the risk (beta) to get 2x the profit.

Once more, these funds are not 2x and 3x the 6 month or 1 year result... but the daily result. Study after study shows how compounding contributes to leverage breakdown (decay/deterioration).

So before hopping in the triple long or triple short saddle, get a gander at how buy-n-hold can burn you badly over time. Here's a 3-year chart of the ever-popular ProShares Ultra QQQ (QLD) and the Powershares Nasdaq 100 (QQQQ). QQQ turned up with a 0% return, while the uninformed buy-n-holder gets -40%! Ouch!

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[MadScientist:]

I agree with your comments on this - there is definitely more risk than return on all of the leveraged ETFs because of their daily reset. This is especially true with the 3x variants, where novice traders can get badly burned if they are not careful.

However, these are still valuable short-term trading vehicles (I usually trade the 2x leveraged ETFs over a 3-6 week period at good returns). As always, and perhaps most specifically with these types of ETFs, good money management practices are essential.

Jul 21 12:49 PM

[Living4Divi...:]

My how investors seem to love derivatives. At first it was short ETFS, and then it was double long ETFs and double short ETFs. Recently, they have introduced triple long and triple short ETFs. Warren Buffet wrote:
“I view derivatives as time bombs, both for the parties that deal in them and the economic system.“

Jul 21 04:50 PM

[Carousel:]

Assuming leveraged ETFs will always have decay/deterioration therefore shorting a leveraged ETF would result in a guaranteed profit. Right?

Jul 21 08:49 PM

[Carousel:]

Assuming leveraged ETFs will always have decay/deterioration therefore shorting a leveraged ETF would result in a guaranteed profit. Right?

Jul 21 08:49 PM

[duffman071:]

Well nothing is ever a guarantee but yes, shorting a leveraged ETF is a great strategy IF you pick the right direction! If you are wrong on direction, you can still lose alot. But right now I'm short FAZ over the long haul and with a long enough horizon, I see little downside risk unless one is predicting utter & complete collapse of the entire financial industry (armageddon doomsday scenario).
It's a very powerful strategy. However, it is sometimes very difficult to find the shares to short. It took me several tries to short the FAZ. And in the past 2 weeks, I haven't been able to short a single leveraged ETF.... and trust me, I've tried every day, multiple ETFs. The problem is this strategy is so popular these days that everyone is shorting leveraged ETFs. No such thing as a free lunch.


On Jul 21 08:49 PM Carousel wrote:

> Assuming leveraged ETFs will always have decay/deterioration therefore
> shorting a leveraged ETF would result in a guaranteed profit. Right?

Jul 22 01:39 AM

[oldman:]

what is the average returns for a day trader and how many trades are made weekly, monthly etc?

I have a friend who started day trading the TZA 3x bear and TNA 3x bull. What's his chance?

Jul 22 10:02 AM

[mkttrdr:]

TNA and TZA trade like stocks but beware if your on the wrong side or hold too long on the " hope im right " factor.

The trend is up as long as the FED and Wh keep pumping money into Goldman from "off shore accounts". So any downside is limited. A break is overdue but may wait for bad news or late OCT-3rd qtr. Good luck.


On Jul 22 10:02 AM oldman wrote:

> what is the average returns for a day trader and how many trades
> are made weekly, monthly etc?
>
> I have a friend who started day trading the TZA 3x bear and TNA 3x
> bull. What's his chance?

Sep 11 11:53 AM