3 Tips for Trading Leveraged ETFs
If you think the stock market is a volatile place, you ought to get a load of ETFs that use leverage.
From Sep. 15 to Oct. 16, the ProShares Ultra 2x Dow 30 Fund (NYSEARCA:DDM) collapsed 10.22%. But from Oct. 16 through Nov. 14, DDM soared 19.50%. That’s a breathtaking swing of 29.72% from negative to positive gains in just a matter of two months!
These types of extremes shouldn’t be a shock because leveraged ETFs are designed to magnify performance. Of course, if you’re on the wrong side of the trade they can also magnify losses.
For example, DDM is a “bullish fund” and it aims to deliver double daily performance to the Dow Industrials (NYSEARCA:DIA). That means if the Dow is up 1%, DDM should theoretically be up 2%. On the other hand, if the Dow falls 1%, DDM will be down 2%.
DXD is the “bearish fund” that does the exact opposite of DDM. In this case, DXD shoots for double daily inverse performance to the Dow Jones Industrial Average.
Leveraged ETFs are often criticized by people within the financial services industry because 1) they don’t understand the products, 2) they don’t understand what part of the portfolio these types of investments go, or 3) they have anti-leverage ETF bias.
In my video, “Rules for Using Leveraged ETFs,” I talk about the time and place for leverage. And below are a few more guidelines.
Trade sharply trending markets
Big performance gains with leveraged ETFs can be had in sharply trending markets. In a bearish market, bear funds that aim for inverse or short performance are likely to excel, whereas in a bull market the bull funds with leverage should be large gainers.
Don’t own too many markets
Leveraged ETFs follow a variety of asset classes beyond stocks including currencies (NYSEARCA:EUO), commodities (NYSEARCA:SCO), real estate (NYSEARCA:DRN), and even volatility (NYSEARCA:UVXY). While it’s nice to have a breadth of choices, simultaneously trading too many markets can become distracting. And distraction often leads to losses.
Leveraged ETFs aren’t Buy-and-Hold Investments
If you’re buying a leveraged ETF, understand that you’re making short-term trade, not a long-term investment. Generally, a short-term trade is one that lasts anywhere from one day up to several weeks. If you’re buying a leveraged ETF as a long-term investment, you’re using the tool the wrong way and is comparable to using a screwdriver to do a hammer’s job.
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