Leveraged ETFs are a sometimes maligned in the financial media.. A lot of the ill will has to do with the fact that they don’t suit the eye of traditional buy-and-hold long term investors. That’s because they’re designed for, and marketed to, active traders.
The leveraged nature of these ETFs, coupled with their daily reset feature means that at times, they may become extremely volatile vehicles with a lot of intraday volume. You might see an LETF like Direxion Daily Junior Gold Miners Index Bull 3X Shares ETF JNUG or ProShares Trust Ultra VIX Short Term Futures ETF UVXY and not realize that they behave a lot differently than your typical ETF.
To help educate those interested in trading ETFs we asked Sylvia Jablonski, the head of capital markets and institutional strategy at Direxion— the largest provider of leveraged and inverse ETFs—to give us four tips she give to people who want to trade these products. Here’s what she told us.
1. Form an opinion on volatility and trend
“You should have a strong opinion on both volatility and the trend before you trade these products,” Jablonski says.
“Leveraged ETFs tend to perform best in low volatility trending markets, whether that trend is upward or downward. A range-bound volatile market is the worst case scenario for a leveraged ETF. That’s when they should really be traded and not held for more than a day.”
2. Know where you’re buying and selling
“Investors should understand what the indicative NAV (iNAV) of a fund is,” she says.
iNAV is essentially the real-time version of NAV. “You’d rather buy as close to the iNAV or at a discount as possible,” says Jablonski. “It’s a good way to gauge the price you’re going to get, and you can see whether you’re buying or selling at a premium or discount to the secondary market.
To get a fund’s iNAV, Jablonski advises using free sites like Yahoo or Alphabet Inc GOOGL Google Finance.
3. Understand how rebalancing works
“There’s a reason we use ‘daily’ and ‘2x or ‘3x’ in the name. It means it’s meant to track two times, or three times the index for one day. A common mistake is traders might look at a given period of time and say ‘Well, this index is up 10 percent over the last 30 days. Why isn’t my LETF up 30 percent?’”
“A common mistake or misconception is that leveraged ETFs are meant to track a period of time multiplied by three, or the relevant Beta point,” she says. “But the daily LETFs are meant to track only one business day of trading from rebalance to rebalance. The performance of daily leveraged etfs over time is the sum of each day’s performance, not the time period in question multiplied by three.”
4. Don’t trade leveraged ETFs if you don’t have the time
According to Jablonski, “leveraged ETFs should really be used by sophisticated active traders who understand the risks, actively trade, and actively monitor their positions.”
These traders should “understand the unique characteristics of levered and inverse daily ETF products...and have time to manage positions frequently to respond to changing market conditions and fund performance.”
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