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Robert Edwards
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Contrarian daytrading technician who specializes in locating high probability short term trades while predicting price movement directions with over 85% accuracy. Most of my trading involves either extremely short term micro scalping of stocks or commodities (using 1 minute bar charts), or swing... More
  • One Trading Strategy That May Hold The Key To Successfully Trading Leveraged ETFs Like NUGT & DUST 3 comments
    Jan 3, 2014 12:18 PM | about stocks: NUGT, DUST, GDX, GLD, ABX, NEM

    Let me begin by saying that if you have not read my article titled, "What Every Trader Must Understand Before They Trade Leveraged ETFs Like NUGT & DUST, click here. I would strongly suggest that one read that article first, as it provides some good basic background information that is critical for trading success. Most importantly, the article explains how leveraged ETFs have time decay slippage, similar to an option. Thus, in trading these ETFs, one must have impeccable timing, or at least one must utilize intelligent money management techniques and take aggressive action when losses begin to mount. The money management techniques include dividing one's money up into 2 or 3 traunches and never be "all in". This way one can recover if one should have to suffer through a reverse split due to extreme price decay. If the underlying gold mining ETF benchmark (NYSEARCA:GDX) loses 25% of its value, it will cause a decay of 75% in NUGT. That is about the maximum drawdown one can sustain when holding long-term, if one expects to have any reasonable chance of recouping their loss. Thus, whenever one purchases NUGT, one should be confident that we are within 20% to 25% of the absolute low.

    To avoid having to ever face the possibility of severe slippage, or worse, a reverse split, it is usually not advisable to hold a position beyond a month, due to the slippage that averages about 10% per month. Day trading or holding positions overnight is most preferred as slippage is negligible. Traders who cannot or do not want to day trade, can still swing trade on about a weekly basis, catching short-term trends that might last from 3 to 10 days.

    How To Best Deal With Price Decay When Trading Triple Leveraged ETFs?

    If you have been following my articles, you are aware of the grand experiment that I have been conducting to see if one can successfully hold the bullish triple leveraged gold mining ETF (NYSEARCA:NUGT) long-term. The jury is still out with no definite answer yet. However, what is apparent, is that the losses one must endure when holding long-term, can be hideously large. Holding through the losses requires nerves of steel. Most traders do not have the emotional stability, the will, and/or the pocketbook, to hold through the severe drawdowns, and will panic and sell out at the bottom.

    Thus, my proposed Rule # 1, when trading NUGT & DUST, would be to set aside no more than 40% of one's trading account for the leveraged ETFs, (to keep overall total account leveraging to a minimum) and to start buying NUGT or DUST with 1/3 of the designated funds. On any given day, I would start with 1/6th of the funds which will allow for a second purchase using another 1/6th of the funds to average down in case one bought in too soon. If one makes a quick profit utilizing 1/3 of the designated funds, then great, one can bank it. But if the market moves against the position, one should not add further to the losing position, but instead now invest up to 1/3 in the opposing fund. If one started out buying NUGT and gets 1/3 invested, one can then buy an equal amount of DUST which will balance out the trade and reduce suffering further losses. One will still have 1/3 of the designated funds left to add to whichever side is making money.

    Suppose that I had implemented this rule when I went long recently in NUGT at $41. As NUGT broke down into the $30s, I would have been forced to buy an equal amount of DUST shares which would have greatly mitigated my losses. Since DUST would have been in a profit and not NUGT, the last 1/3rd of my funds would have been placed in DUST so in effect, I would have been long 1/3 DUST at the $24 bottom, and likely in a net profit situation, instead of the severe drawdown that I did suffer through.

    At some point I could take profits in DUST and then add to my NUGT shares near the bottom, greatly reducing my breakeven price. Although one cannot add to a losing position initially, once one is 100% invested with the funds designated for NUGT & DUST trading, after one takes profits on the winning side, one can then allow oneself to add to the losing side, following an extreme move.

    In fact, with this one rule in place, one can in fact use the entire account for NUGT and DUST trading and not limit oneself to 40% of the entire account. When starting out, one will never have more than 1/3rd committed to one direction or the other. However, once 100% of the funds are committed, when one decides to take profits on the 2/3rds of the account that is a winner, one can risk using some of the proceeds to buy some losing shares to average down the loss.

    The drawdowns one will experience utilizing this money management technique, should be quite small and easily manageable. Also, it forces one to add to the winning side of the trade, which is almost always preferable to adding to a losing trade. Also, playing the teeter totter (trading DUST and NUGT simultaneously and taking profits on which side has them and then waiting for the other side to pop back up, as Lefty6x6 suggests), has some definite positives. I would be curious to get the thoughts of others.

    Disclosure: I am long NUGT.

    Additional disclosure: Also in and out of NEM and GDX

    Stocks: NUGT, DUST, GDX, GLD, ABX, NEM
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Comments (3)
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  • Growfast
    , contributor
    Comments (275) | Send Message
     
    RE - I think this is a great approach, especially if the "trend" is not clear, as it wasn't when we entered NUGT around 41. And, if a clear trend doesn't establish, the Lefty6x6 teeter totter play works to make money rather than just allow time decay on a single position on either side of the trade.

     

    And, if the trend is clear, your approach works as well as one could add additional funds to the winning direction.

     

    Another way of accomplishing something similar, which I did for a period of time, if one has options approved for their account, would be to put a protective put, or a protective call in place to counter the initial position instead of using just NUGT or DUST.

     

    Example:
    1/3 invested in NUGT. Trend begins to move against.
    - Buy protective NUGT put that begins to profit for moves against NUGT.
    - Or, buy a protective DUST call that would profit in moves against NUGT.

     

    Options provide additional leverage, meaning less funds could be used to hedge the risk in a position where one strongly believes the trend will eventually kick in - while also producing the same profit as if DUST was held.

     

    If one expects the trend to be downward, so initial 1/3 investment is in DUST, the hedge positions would be the reverse of above.
    3 Jan, 12:53 PM Reply Like
  • glaserdx
    , contributor
    Comments (211) | Send Message
     
    Rob - will implement 1/3 $ strategy & teeter totter. Thanks!
    Grow- can you provide example when to buy put, strike price, expiration, etc. possibly from your past trades? Would be very helpful.
    3 Jan, 03:22 PM Reply Like
  • Growfast
    , contributor
    Comments (275) | Send Message
     
    I posted a supplemental Instablog article to this article, that provides an alternative leveraging options. The link to the Instablog is here: http://seekingalpha.co...
    3 Jan, 06:30 PM Reply Like
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