How do I trade leveraged ETFs?

[Sam Button]

[Sheila Olson]

Before you jump into leveraged ETFs, you should understand how they work and what they are designed to accomplish. Leveraged ETFs aim to double or triple the performance of an asset, such as gold or oil, or an index such as the S&P 500 using debt instruments and derivatives. What makes them unusual—and exceptionally volatile—is that they provide leveraged exposure on a one-day basis. The funds are rebalanced each day, which means the fund’s performance will vary wildly from the performance of the underlying asset over time. These funds are not suited for long-term investment, and in fact, most traders don’t hold them overnight, because any gains made on the day can easily be wiped out by after-market events. This risk is spelled out clearly in the ProShares prospectus for geared funds such as the Ultra QQQ: “For periods longer than a single day, the fund will lose money when the level of the index is flat, and it is possible that the fund will lose money even if the level of the index rises. Longer holding periods, higher index volatility and greater leverage each exacerbate the impact of compounding on an investor’s returns.” If you’re still inclined to day trade leveraged ETFs, there are a few guiding principles to keep in mind. Develop a good technical trading strategy and confirm signals with multiple indicators. With leveraged products, you can lose your entire investment in a very short period of time, so you need to carefully calibrate your entry and exit points. Be aware of outside factors affecting the underlying index or asset. Some of the most popular leveraged ETFs track indices such as the NASDAQ, the Russell 2000, the S&P Biotech Index, and the MSCI Emerging Markets Index. These are all influenced by various macroeconomic factors including Federal Reserve announcements, volatility in the bond and futures markets, and even political events. Look at multiple timeframes. Even though you’re day trading over a period of minutes, you need to be aware of the larger, overall trends, and especially strong levels of support and resistance that have been tested over the prior day’s (or even week’s) trading. This will help you more reliably determine entry and exit points. Take a disciplined approach to stops. Leveraged products compound gains and losses, so you need to set stops tight enough to mitigate risk, but not so tightly that you’re kicked out in the middle of a run in the direction of your trade. Know when to close a trade and take your loss. Some investors practice averaging down, which is fine for long-term strategies, but it’s a terrible idea for day traders, especially with geared funds. Know what you’re willing to risk on a particular trade and stick to it.

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