1stmilliondollar.net

A financial journey to our first million dollar

Posts Tagged ‘leveraged’

Market Pullback = Buy Leveraged Bull ETF?

May 11th, 2010

I am sure that all of you know that we had a market pullback last week. Dow Jones Industrial Averages lost about 700 points in a week. Although the market has rebounded yesterday, we can expect high volatility in the next couple of days.

I heard that some people are buying leveraged bull ETFs in this pullback. Their rationale is that we are still in a bull market. This is only a temporary pullback. The market should make a new high soon. By buying leveraged ETFs, they hope to double or triple their profits.

For those who don’t know about leveraged ETF, you can read our previous posting, Leveraged ETF = Getting Rich Quickly. A leveraged ETF is basically a financial derivative that amplifies the return of the underlying index. For example, SSO is a double (2x) leverage ETF of S&P 500 from ProShares. It means, when S&P 500 goes up 1% on a single day; this ETF goes up 2% in price. On the other hand, when S&P drops 2%, this ETF drops 4%.

Should we buy leveraged ETFs? Personally, we had a bad experience with leveraged ETFs in the last market crash. Here is the story:

When leveraged ETFs are still pretty new to the market about 3 years ago, we bought them with a large amount of money. We didn’t do enough research. We didn’t even realize that it amplifies the underlying index on a daily basis. Then, it came market crash in 2008. That’s when we realize that this product is just garbage. As we pointed out in our previous posting, SSO lost –46% from 2006 to 2010; while the underlying index, S&P 500 lost only –11%.

Our recommendation, stay away from leveraged ETFs. It is not a good investment vehicle. If you want to do day-trading with them, it is up to you.

Link

Leveraged ETF = Getting Rich Quickly

2 comments »

Posted in Investment

Tags: ETF leveraged pullback

Leveraged ETF = Getting Rich Quickly?

February 27th, 2010

Are you familiar with leveraged ETF? For those who don’t know, here is the description from Investopedia.com:

An exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index.

These ETFs are usually double (2x) or triple (3x) the underlying index. For example:

SSO is a double (2x) leverage ETF of S&P 500 from ProShares. It means, when S&P 500 goes up 1% on a single day; this ETF goes up 2% in price. On the other hand, when S&P drops 2%, this ETF drops 4%.
EDC is triple (3x) leverage ETF of MSCI Emerging Markets Index from Direxion. It means when the index goes up 1%, this ETF goes up 3% in price. The same is true for the downside.

Is this an easy to way to get rich quickly? When these ETFs were pretty new in the market a couple of years ago, we think it is. We were dreaming that we could easily beat the index by investing in these ETFs. We didn’t do more research at that time. We invested *a lot* of money in a couple of leveraged ETFs. What happened then? We were totally doomed, especially during the recession.

These ETFs amplify the underlying index only on a single day. It doesn’t accumulate for longer period of time. Let’s take an example:

Day 0: S&P 500 is at 1,000. Our triple leveraged ETF for S&P 500 is at $100.
Day 1: S&P 500 goes down by 10% to 900. Our ETF drops 30% to $70.
Day 2: S&P 500 goes up by 12% to 1008. Our ETF goes up by 36% to $95.2.

As you can see, after the second day, S&P 500 is higher than day 0; but our ETF is still below day 0.

The chart below the comparison of SSO and S&P 500 from June 2006 to today. As you can see here, the return of S&P 500 in this period is –11.66%. However, the return of SSE is –46.93%.

Be really careful when investing in leveraged ETFs. We don’t invest in any of leveraged ETFs today.