Trading Leveraged ETFs: No One’s Complaining in a Bull Market

by: David Fry

We’ve been fans of using leveraged and unleveraged issues since they first became available. The introduction of these issues made it possible for retail investors and financial advisors to construct hedge-fund like investment strategies.

There has been controversy regarding these issues coming out of the recent bear market that perhaps ended in the spring of 2009. It’s natural to look for scapegoats even beyond the obvious toxic derivative mess. One area singled-out was the low hanging fruit of leveraged short ETF issues being offered. The media and regulators pounced on a few issues many felt didn’t achieve results investors expected. This was primarily due to a lack of understanding as to how these issues functioned given market volatility, daily resets and compounding effects.

And, perhaps not so curiously, no one’s been complaining about leveraged long products as markets have risen off March lows.

But, there were problems with these products such as holding them on a long-term basis over many months. This led investors to actually lose money on a few issues where they believed they should have profited. This “buy and hold” approach has proven a poor use of what can be very good products when used properly.

Our experience has revealed excellent short-term trading results when these issues are traded over periods of one or two week holding periods. While not perfect in tracking their respective index and whether using 2 or 3 times leverage, results have been impressive in this regard. If investors have a satisfactory short-term trading strategy and are disciplined and systematic, then adding an additional return of 2 or 3 times is attractive and achievable.

We’ve been able in a short period of time to capture 5-7% returns and more over short time periods as previously described. Naturally, not all trades are successful and losses of a similar amount have also been experienced. Nevertheless, all things considered, when winners exceed losers by a significant amount, then this is a suitable methodology for the most aggressive investors.

Investors utilizing an aggressive trading strategy as we’ve described must understand the risks associated with it; higher trading costs if using a conventional broker; a frenetic level of activity; and risk of loss.

While most investors don’t wish to trade this actively, there exists a significant audience who wish to do so. Further, many investors are seeking alternative choices to conventional trading issues such as more complex and riskier futures and options strategies.

There are also many investors who may wish to occasionally hedge their long exposure to markets during periods of short-term stress. Utilizing short leveraged or unleveraged short ETF issues in a tactical fashion over short time periods is an appropriate strategy, making these issues useful tools so long as investors approach these issues in a disciplined and systematic manner.