Double Your Return And Reduce Drawdowns When Using An ETF Of The Nasdaq 100 Index

| About: ProShares Ultra (QLD)

Would buying the ProShares Ultra QQQ (NYSEARCA:QLD) do that? It has a built-in (structural, not margin-based) leverage that is intended to double the price gains of the index.

Maybe, if the market is just going up. Let's see what the history has been over the last 5 years.

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(YAHOO Financial)

The market as measured by the S&P500 (NYSEARCA:SPY) is up about +30% and the Nasdaq 100 (NDX) rose +50%, while QLD gained nearly +100%, all over the full 5 years. Pretty fair annual rates of gain above SPY's +5.4%, with the NDX gaining at a +10% rate, and QLD climbing by +13.3% a year.

But it would take cajones of stainless steel or a year's mid-ocean island isolation from civilization without a cell phone or any other form of communication to resist an interim emotionally driven salvage of one's remaining one-third to one-half of the capital they thought they had in August of 2008.

The notion of a rational, informed investor following a buy-and-hold investment policy throughout this 5-year period is a fantasy of mental masochism. And who knows how long it would take that seriously wounded investor to convince him/herself that the tide had actually turned, and be willing to come back in and risk another catastrophe?

Instead of the original B&H investment policy mistake, see what a time-and-risk disciplined active management policy produces. One that sets explicit unchangeable sell targets for each commitment, and limits every position to a pre-set holding period maximum. One where the timing of buy actions are driven by the prior experience of market professionals whose forecasts then were like they are today.

Our standards for such an approach is to use the top of a day's future price range forecast by market-makers, implied by their self-protective hedging actions, as a sell target and allow every holding no more than 3 months to reach its target, or be summarily closed out.

Here is what that discipline produced for QLD over the past 5 years, examined in every one of the period's 1261 market days.

Their current price range forecast puts an upper expectation +8.6% above the ETF's market price. Its downside possibility of $65.57 is a drawdown about half as large as the upside potential seen, so about one-third of the forecast price range is below the current quote. A bit more precisely, we measure that dimension in a Range Index of 34, instead of the rough estimate of 33.

To test how today's forecast opportunity worked out in the past 5 years, we find that Range Indexes with at least as attractive an upside-to-downside balance occurred in 229 of the period's 1261 days. A buy in every one of them, following the discipline, produced average gains of +8.9%. Seven out of every eight such positions were profitable, or a win-ratio of 87 out of 100.

More importantly, the average period of all holdings, including those eighth ones that ran to a full 63 market days, was only 33 days, about 4 ½ weeks. That allows better than seven times in each year to compound those nearly +9% gains. The annual rate when achieved perfectly (which hardly ever happens) would be +93%. But with this kind of opportunity appearing once in every week or so on average, such a reward rate can realistically be approached.

The active management discipline offers wealth-building opportunity here at several times the buy and hold rate for the QLD of but 13.3%.

The best part of this discipline is found in the drawdown risk experiences. For each of the 229 hypothetical holdings, the worst-case condition of an end-of-day market quote below the initial entry price was noted. They averaged only -7.6%, well under the +8.9% average gains achieved, and within the tolerance limits of most experienced investors.

Larger drawdowns from high-water prices have occurred several times in the market indexes since the market's upturn in March 2009.


Despite the general market's recent advance, the outlook for future prices of the ETF QLD appears quite attractive, given the prior experiences of knowledgeable market professionals from whom the forecasts are derived. Best results should come from an active investment practice, but even in a longer-term, less disciplined philosophy, this may be a better than average time to buy QLD.

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.