Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
CATHY WOOD ARK GARBAGE ARK Funds Heading for 90% STOCK CRASH! - 22nd Jan 22
Gold Is the Belle of the Ball. Will Its Dance Turn Bearish? - 22nd Jan 22
Best Neighborhoods to Buy Real Estate in San Diego - 22nd Jan 22
Stock Market January PANIC AI Tech Stocks Buying Opp - Trend Forecast 2022 - 21st Jan 21
How to Get Rich in the MetaVerse - 20th Jan 21
Should you Buy Payment Disruptor Stocks in 2022? - 20th Jan 21
2022 the Year of Smart devices, Electric Vehicles, and AI Startups - 20th Jan 21
Oil Markets More Animated by Geopolitics, Supply, and Demand - 20th Jan 21
WARNING - AI STOCK MARKET CRASH / BEAR SWITCH TRIGGERED! - 19th Jan 22
Fake It Till You Make It: Will Silver’s Motto Work on Gold? - 19th Jan 22
Crude Oil Smashing Stocks - 19th Jan 22
US Stagflation: The Global Risk of 2022 - 19th Jan 22
Stock Market Trend Forecast Early 2022 - Tech Growth Value Stocks Rotation - 18th Jan 22
Stock Market Sentiment Speaks: Are We Setting Up For A 'Mini-Crash'? - 18th Jan 22
Mobile Sports Betting is on a rise: Here’s why - 18th Jan 22
Exponential AI Stocks Mega-trend - 17th Jan 22
THE NEXT BITCOIN - 17th Jan 22
Gold Price Predictions for 2022 - 17th Jan 22
How Do Debt Relief Services Work To Reduce The Amount You Owe? - 17th Jan 22
RIVIAN IPO Illustrates We are in the Mother of all Stock Market Bubbles - 16th Jan 22
All Market Eyes on Copper - 16th Jan 22
The US Dollar Had a Slip-Up, but Gold Turned a Blind Eye to It - 16th Jan 22
A Stock Market Top for the Ages - 16th Jan 22
FREETRADE - Stock Investing Platform, the Good, Bad and Ugly Review, Free Shares, Cancelled Orders - 15th Jan 22
WD 14tb My Book External Drive Unboxing, Testing and Benchmark Performance Amazon Buy Review - 15th Jan 22
Toyland Ferris Wheel Birthday Fun at Gulliver's Rother Valley UK Theme Park 2022 - 15th Jan 22
What You Should Know About a TailoredPay High Risk Merchant Account - 15th Jan 22
Best Metaverse Tech Stocks Investing for 2022 and Beyond - 14th Jan 22
Gold Price Lagging Inflation - 14th Jan 22
Get Your Startup Idea Up And Running With These 7 Tips - 14th Jan 22
What Happens When Your Flight Gets Cancelled in the UK? - 14th Jan 22
How to Profit from 2022’s Biggest Trend Reversal - 11th Jan 22
Stock Market Sentiment Speaks: Are We Ready To Drop To 4400SPX? - 11th Jan 22
What's the Role of an Affiliate Marketer? - 11th Jan 22
Essential Things To Know Before You Set Up A Limited Liability Company - 11th Jan 22
NVIDIA THE KING OF THE METAVERSE! - 10th Jan 22
Fiscal and Monetary Cliffs Have Arrived - 10th Jan 22
The Meteoric Rise of Investing in Trading Cards - 10th Jan 22
IBM The REAL Quantum Metaverse STOCK! - 9th Jan 22
WARNING Failing NVME2 M2 SSD Drives Can Prevent Systems From Booting - Corsair MP600 - 9th Jan 22
The Fed’s inflated cake and a ‘quant’ of history - 9th Jan 22
NVME M2 SSD FAILURE WARNING Signs - Corsair MP600 1tb Drive - 9th Jan 22
Meadowhall Sheffield Christmas Lights 2021 Shopping - Before the Switch on - 9th Jan 22
How Does Insurance Work In Europe? Find Out Here - 9th Jan 22
MATTERPORT (MTTR) - DIGITIZING THE REAL WORLD - METAVERSE INVESTING 2022 - 7th Jan 22
Effect of Deflation On The Gold Price - 7th Jan 22
Stock Market 2022 Requires Different Strategies For Traders/Investors - 7th Jan 22
Old Man Winter Will Stimulate Natural Gas and Heating Oil Demand - 7th Jan 22
Is The Lazy Stock Market Bull Strategy Worth Considering? - 7th Jan 22
METAVERSE - NEW LIFE FOR SONY AGEING GAMING GIANT? - 6th Jan 2022
What Elliott Waves Show for Asia Pacific Stock and Financial Markets 2022 - 6th Jan 2022
Why You Should Register Your Company - 6th Jan 2022
4 Ways to Invest in Silver for 2022 - 6th Jan 2022
UNITY (U) - Metaverse Stock Analysis Investing for 2022 and Beyond - 5th Jan 2022
Stock Market Staving Off Risk-Off - 5th Jan 2022
Gold and Silver Still Hungover After New Year’s Eve - 5th Jan 2022
S&P 500 In an Uncharted Territory, But Is Sky the Limit? - 5th Jan 2022

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Truth About 'Leveraged ETFs'

Companies / Exchange Traded Funds Jan 23, 2011 - 08:54 AM GMT

By: Jared_Levy

Companies

Best Financial Markets Analysis ArticleBack in early October, after a visit to the Texas State Fair, I wrote about inflation and the global food "problem" and how you can take advantage. Every stock I mentioned in the report has seen substantial runs since then.

Keeping all of our greed under control, Sara recently detailed why commodities and the agri-stocks climbing with them needed a nap, and why maybe it was time to take profits.


What does this have to do with leveraged ETFs, you might be asking? Well, I thought I would use food as an intro, because it offers a great analogy for my views on leveraged ETFs (OK, and maybe I wanted to remind you how Smart Investing Daily keeps you ahead of the curve).

Both gluttony and greed are two of the "seven deadly sins," but with food especially, some of us tend to eat more than we need to and with that, the very thing that brings us life and energy can also cause illness disease and death (in severe cases). I bring up these morbid reminders, not to scare you out of satisfying your hunger for food, but to remind (or inform) you that some investment vehicles (leveraged ETFs) might be just as unhealthy and perhaps even dangerous for your portfolio, forcing you to "eat" fees and expose yourself to risks you may not even be aware of. Too much of something is not always a good thing.

Leverage
According to Wikipedia, "leverage is a general term for any technique to multiply gains and losses." You can attain leverage by borrowing money, purchasing fixed assets or using derivatives like options or futures. Basically, you can think of it as using a lesser amount of money to buy (or sell) a larger amount of something like a stock or other investments.

Leverage can be a good thing of course; many of us use our credit as a source of leverage, so we can purchase high-ticket items now that we feel may rise in value (take your home, for instance).

You also use leverage when you purchase a stock on margin from your broker.

There is no such thing as a free lunch; for that leverage we have to pay fees, costs, interest, etc. (These are called carrying costs.) Hopefully the amount that we are paying in carrying costs is less than the appreciation or income we are receiving from the asset we have leveraged.

If we take on too much leverage and the asset doesn't appreciate or even worse, decreases in value, you will still have to digest tons of carrying costs. You will have to "consume" those costs with nothing to show for it, except for maybe heartburn, caused now by stress.

Greed and Leveraged ETFs
Leveraged ETFs like Direxion Daily Financial Bull 3X Shares (FAS:NYSE), Direxion Daily Financial Bear 3X Shares (FAZ:NYSE), Direxion Daily Gold Miners Bear (DUST:NYSE), Direxion Daily Real Estate Bull 3X Shares (DRN:NYSE) and many others have become extremely popular; they enable you to maybe make $2 or $3, even when a stock or index were to only move $1 (of course you would lose $2 or $3 for a $1 move in the opposite direction). There are even ETFs that move opposite to the way the underlying stock or index is moving. So if the stock is UP $1, the ETF would be DOWN $1 or $2 or $3, depending on what type of leverage they are using (talk about confusing).

For that leverage, ETFs charge you a fee -- more on that in a second.

Leveraged ETFs are not evil; if you know exactly what you are doing, how they work and how to invest in them, you can profit. The reality though is that the "leveraged" part appeals to the greedy side of most retail investors, who have minimal knowledge of the way they work and end up losing money because they didn't do their homework.

(Investing doesn't have to be complicated. Sign up for Smart Investing Daily and let me and my fellow editor Sara Nunnally simplify the stock market for you with our easy-to-understand investment articles.)

The Mechanics of Leveraged ETFs
Leveraged ETFs were specifically created for professionals and short-term traders and most have nuances you must understand before investing even $1 into them.

Here is an example, using the Direxion Daily Financial Bull 3X Shares (FAS:NYSE), which is a very popular leveraged ETF.

The FAS is purported to return 3X (300%) the movement of the financial sector index on a daily basis, which it can do so, but not all the time and not if held for a duration longer than a day (yes, a day).

Here are some nuances of the FAS:

  • FAS bases its return off of the Russell 1000 financial index (RIFIN.X) (make sure you know what the ETF you are trading is based off of, it may surprise you).
  • FAS charges about 1% per year in basic expenses; there are also transaction costs and tax implications you should discuss with your financial and tax advisor.
  • Most leveraged ETFs like FAS use derivatives and complex financial instruments like total return swaps to gain their leverage, which are created by and traded with firms like Goldman Sachs, UBS, Deutsche Bank and others, they (you) pay those firms a fee to provide this.
  • Returns of the ETF over time may NOT be even close to the returns of the index it's tracking!

Get this -- In 2009, the Russell 1000 financial index was up about 30%. You would think that the FAS should be up three times that (maybe 90%) in the same time frame. Wrong! The FAS actually lost 34%, so if you were completely correct in your trade and held the FAS for a year, you lost money!

The Devil Is in Daily Rebalancing
Most leveraged ETFs get their leverage only for the day and then at the end of the day, that leverage resets, which can hurt you in the long term. This is the biggest profit siphon when investing in a leveraged ETF.

*Check out what happens if the Russell 1000 index moves up 3% today and drops 3% tomorrow and you are long the FAS.

If you bought FAS today at $30, it would move up about $2.70 (9%). At the end of today, the ETF would actually take those profits and invest them the next day starting fresh (this is rebalancing).

So tomorrow, you now have $32.70 invested at three times leverage, so if the Russell index then drops 3%, the FAS would drop 9% (of $32.70) and you would now lose $2.95, leaving you with a net loss of $0.25, even though the underlying index is actually flat.

Scared, Confused or Both?
In closing, don't get sucked in with the lure of leverage, it may just leave you with a really bad case of high carrying costs and losses in your account. Know what is in the ETF and how it works before you trade. If you do trade them, you should only be trading very short term, less than three days, preferably intraday.

P.S. Join Smart Investing Daily's Sara Nunnally as she sits down for a one-on-one discussion with Jordan Goodman of The Money Answers Show. Sara will discuss the new book, Barbarians of Wealth, she co-authored with Taipan's Executive Publisher Sandy Franks... and how you can protect yourself against today's greedy, self-serving barbarians in Washington and on Wall Street.

The Money Answers Show with Jordan Goodman airs on Monday, Jan. 24th at 12 pm PT. You can learn more about Sara's interview here.

Editor's Note: "The 30% Stepping Stone"! Did you know you could make a certain 30% return... every 12 months... without a bit of risk? Transform your financial destiny with Wealth Legacy Advisory.

Don't forget to follow us on Facebook and Twitter for the latest in financial market news, investment commentary and exclusive special promotions.

Source : http://www.taipanpublishinggroup.com/tpg/smart-investing-daily/smart-investing-012111.html

By Jared Levy
http://www.taipanpublishinggroup.com/

Jared Levy is Co-Editor of Smart Investing Daily, a free e-letter dedicated to guiding investors through the world of finance in order to make smart investing decisions. His passion is teaching the public how to successfully trade and invest while keeping risk low.

Jared has spent the past 15 years of his career in the finance and options industry, working as a retail money manager, a floor specialist for Fortune 1000 companies, and most recently a senior derivatives strategist. He was one of the Philadelphia Stock Exchange's youngest-ever members to become a market maker on three major U.S. exchanges.

He has been featured in several industry publications and won an Emmy for his daily video "Trader Cast." Jared serves as a CNBC Fast Money contributor and has appeared on Bloomberg, Fox Business, CNN Radio, Wall Street Journal radio and is regularly quoted by Reuters, The Wall Street Journal and Yahoo! Finance, among other publications.

Copyright © 2011, Taipan Publishing Group


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in