Q&A: Why Can’t Leveraged ETFs be Bought and Held?

Q&A: Why Can’t Leveraged ETFs be Bought and Held?

Dear ETFguide,

You and just about all the other ETF specialists are very adamant about using leveraged ETFs as short-term trades only.

Please comment about what I’ve done for a 5-year period of time that I’ve outlined below.

I’ve been investing in the ProShares 2X leveraged S&P 500 ETF (NYSEARCA:SSO). My calculations are from charts over the past 5 years. I use the 5 year period of time because I’m a long term investor and for longer than 5- years we have been in a very substantial positive market with but a few minor blips along the way.

According to my calculations (and using the S & P 500 ETFs) if you had invested in SPDR S&P 500 ETF (NYSEARCA:SPY) (1X unleveraged) and SSO (2X leverage) the following figures are true:  SPY was up 84% from 11/21/09 to 11/21/14. SSO was up 248.8% during the same time period…even nicer.

If at any time the SMA or EMA if you prefer (simple and exponential moving averages) for these ETFs fell below a certain predetermined level of your own choosing (such as 50DMA or 200DMA) and held for 3 closing days, you’d exit the position and wait for the trendline to rise above that moving average and make sure it held for 3 days before reinvesting.

This works so well that it’s scary and would almost guarantee a substantial profit over time. Do not expect great results unless you follow this technique for at least 3 years. Using the S&P 500 you have good diversification and there would be minimal trading in and out depending upon the moving average you use. Using 2X leverage gives you substantial upside potential in a bull market and going into cash or equivalents when there’s a downturn helps preserve capital and prevents catastrophic losses.

Do you see any problems with this method? I’ve been using it for a long time and have gotten exceptional results particularly in this strong bull market.

M.K. in Westborough, MA

*******

Dear M.K.,

Using leveraged 2x (double) and 3x (triple) ETFs (NYSEARCA:SPXL) as buy-and-hold long-term investing vehicles isn’t how they were built to be used. However, that doesn’t necessarily mean you’ll have unsatisfactory results if you use them that way and you’re living proof.

We plotted a 5-year chart of SSO vs. the S&P 500 index (SNP:^GSPC). (See below) The first observation is that SSO is a 2x daily levered S&P 500 fund and it gained 245%. Shouldn’t it have gained 172% or double the S&P 500’s five-year 86% return? The answer is no and it’s mainly because SSO is built to deliver 2x daily exposure to the S&P 500, not 2x annual or 2x multi-year exposure. For that reason, SSO’s performance over a year or many years will often deviate from the straight up 2x annual or 2x multi-year performance return of the S&P 500.  Again, these performance discrepancies over longer periods are normal and should be expected.

SSO Chart

The proper place for leveraged ETFs – for you and whoever else decides to use them – is always in the non-core part of your investment portfolio. Are you using them that way? Have you already built the foundation of your portfolio with low cost exposure to the five major asset classes? If you haven’t, then you have no business owning leveraged anything. (Read our latest post on portfolio construction for more on core vs. non-core portfolios)

The trading system you’ve developed with SSO – so long as it stays above your SMA or EMA criteria – has worked like a charm during this particular market cycle. Congratulations! But like all trading systems, these tehniques aren’t necessarily error proof or without consequences. For example, you’ve absorbed considerable volatility – more than most people can probably tolerate.  Also, you’ve encountered an extremely favorable market climate for hyper-bullish trades where just about anything 2x or 3x leveraged long equities (except for gold miners)  has been a moonshot.

Bear markets are particularly good at dismantling trading strategies that were previously deemed as indestructible and your neat little system is no different. Eventually, the unfortunate day will arrive when your trading strategy won’t work and you’ll need to find a new system. Financial markets are dynamic (NYSEARCA:IVV) and constantly changing. And that’s why rigid methods that don’t recognize change by adapting often fail.

On a positive note, your trading strategy uses a strict buy/sell discipline. Isn’t that something more traders and investors should be doing?

Thanks for the question M.K.  and we hope continued success to you.

Tweet your ETF/investing questions to us @ ETFguide

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13 comments on “Q&A: Why Can’t Leveraged ETFs be Bought and Held?
  1. I have to echo a few of the points that Herb raises, namely,
    1. the fact that the strategy has been successful for a particular five year period does not imply that it will continue to be successful
    2. if the strategy proves to be wildly successful and gains some notoriety, there is a strong likelihood that it will become a victim of its own success, i.e., the impact of others either using the strategy or recognizing its widespread has frequently led to changes in the market itself.

    Regarding your first point, a leveraged index ETF will thrive under two conditions:

    i. the underlying index continues to rise
    ii. the volatility of the index (on a daily basis in this case) is low.

    The S&P 500 has met both of these conditions over the past five years. Even if you didn’t withdraw funds during periods where the index dropped below a moving average for three days, you probably would have made out well.

    But if you were to apply this same approach to another index has demonstrated greater volatility, I suspect your results would not be impressive.

    The reason that so many pundits berate current leveraged index ETFs for a buy-and-hold approach is that volatility of the underlying index can not only erode profits, it can cause investors to lose money even when they correctly forecast the long-term trend.

    I have studied this phenomena at length and have gone so far as to develop an alternative structure for leveraged index products (including ETFs) that provide the benefits of leverage along with immunity to the value erosion caused by volatility. But, as of this writing, managers of leveraged ETFs have been so focused on their current client base who use leveraged ETFs for short-term purposes, that they have ignored the market for buy-and-hold investors.

    • paul says:

      I don’t get some of these conclusions. I get that if you are on the wrong side of a trend and in the leveraged etf you are toast but the opposite is also true. If you bought tqqq in 2011 it was $3 and if you sold at top that was $72 a few months or 12 mos back. This includes all fees and decay. Sure one could have daily traded for more or less we can understand.

      • Ronald Delegge says:

        Hi Paul, if you did hold TQQQ from 2011 to recently that’s a 7-year holding period for a product that was designed for holding periods of just days to weeks. If you want to extend your holding periods, it’s better to use put options that expire in 1 to 1.5 years on the ETF ticker you’re bearish on. In many cases, you can risk less capital in the puts while having a slightly longer time horizon to let your bearish trade develop and hopefully blossom. I hope this helps, check out our podcast and also, be sure to subscribe to our free inverse/leveraged ETF Guide at https://www.etfguide.com/snapshot

  2. TR says:

    M.K.,

    I’m sure your sitting in a nice position if you have continued with this strategy. I was wondering if you have an update as of 3 years after you wrote this letter. I started trying this myself a few months ago. As a college kid I have started with a smaller amount but started early. Just wanted to see how it works over an even longer time period. Thanks

    • GH says:

      TR,

      Try using a 5/15 EMA crossover as a strategy to trade any stock or ETF. That should be a guide for buying and selling vs. buy and hold.

      • TR says:

        When the 5 EMA crosses the 15 EMA is that when you sell, and vise versa for buying?

        Thanks for you guys helping the younger students of the market. I hope to some day be able to beat the market not just by luck.

  3. LM says:

    My situation was dumb luck. DIdn’t realize that my father had moved my IRA into 99% TQQQ in March of 2013, then he passed away, and no one was monitoring. I thought all his investments for me were generally low-medium risk. It has had an annualized return of 52% over the past 6 years, and I just discovered this situation in March, 2019. Difficult to sell after such an amazing lucky streak.

  4. warren yost says:

    All pundits warn against leveraged etfs for long term investors, but, entered after confirmed major pivot points, returns can be astonishing. Leap options reduce danger; for that matter, one could sell option premium seeking to acquire the underlying. It is all a matter of timing and portfolio proportion. Sometimes potential reward is worth the risk.

  5. Jeff Adams says:

    Hello, I’m hoping someone can help me. I recently set a lot of money down on UCO, a leveraged ETF. Because a friend who is a broker suggested it. I am totally new to this so I think I made a big mistake. I did it Tuesday after they did a reverse split on Monday. But I didn’t even know what any of this meant. I had only been Trading for a couple of weeks and had been doing so successfully up until this point. Tuesday the shares are bought at $23 dropped down to like 11. When I realized everything that was going on I became very worried and I haven’t been able to sleep since and I’m still trying to figure out if I should just sell what I have at $16 a share or if I should wait and just see if it will go up to at least 20. Then I want to walk away and never do this again. LOL. This all seems super complicated to me and I’m hoping I’m not missing something here but it sounds like people are saying you don’t want to sit on me shares for more than a day and I’ve already been on them 2 days now. Do you think I can recoup some of my losses in the next day or two or is there something I’m missing here? It seems like things are starting to go up a little bit but I really don’t know how any of this works and I just want to get away from it. I know you guys can’t predict the future but I just want to see if you think there’s at least a good possibility things can get better and I can recoup here or am I just digging my grave deeper these are the nature of these OCU stocks?

    • Ronald Delegge says:

      Hi Jeff,

      For the benefit of our other readers, UCO is the ProShares Ultra Bloomberg Crude Oil ETF. It’s a bullish oil ETF and it aims for two times (2x) the daily performance of the Bloomberg WTI Crude Oil Subindex.

      Mistake #1: Buying a leveraged ETF whose underlying asset is strongly trending in the OPPOSITE direction that you want to trade in. You’re bullish on oil, but oil is still crashing and UCO is the last ETF you’d want to buy when the trend is strongly going against you.

      Mistake #2: Using the wrong ETF to express your bullish oil thesis. Instead of using a leveraged bullish ETF, perhaps a better play on oil would be to buy stocks in the beaten up energy sector like ticker symbol XLE. It tracks S&P 500 energy stocks and has no leverage. As stated before, using leverage is a no-no when the assets are NOT trending in the same direction as your bullish bias.

      Final question: Should you bail on UCO? I’ll give you the advice of my beloved late Uncle Louis who told me the following: “Whenever you’re convinced that you must absolutely buy or sell _________ ONLY DO HALF. The worst that can happen is you’ll only be half wrong.”

      Hope this helps and be sure to check out ETFguide TV along with our suite of online classes. Both will definitely help you to make better and more informed investment decisions.

      https://etfguide.teachable.com/

      https://www.youtube.com/etfguide

  6. Geoffrey says:

    I am sorry but I tend to disagree with the analogy here completely. If you look long term at TQQQ, UPRO and UDOW their returns far surpass QQQ, S&P 500 and the DOW. The only way for these funds to go to 0 is if those markets go down by more than 33.3%. (3X33.3% = 100%)although I highly doubt that would ever happen.

    Case in point, I have held UPRO and UDOW for over this COVID-19 when the Dow went from 29,000 all the way down to 18,500. This is more than 33% but yet my funds didn’t go to zero. In fact as I write this my UPRO is now in the green.

    I have now gone 100% opposite of what is shown above and have put a small account $10,000 in TQQQ only. In fact I plan to dollar cast average and buy shares on a regular basis.

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