I got a refreshing reminder of that talking to someone who had
lost a lot by buying and holding a leveraged ETF.
The crux of the issue is the "constant leverage trap"-a term
that applies to funds that reset their leverage daily. In short,
the constant leverage trap means that in trendless, volatile
markets, leveraged ETFs lose far more of their value than you'd
Explanations of the constant leverage trap abound on the Web,
and they're worth a review if you're considering-or already
invested in-leveraged ETFs. (See this IndexUniverse webinar and an
article by New York University's Marco Avellaneda and Jian Zhang
published a year ago in "Risk Professional.")
Even after a reminder of how the returns on these funds erode in
volatile markets, there are a couple of points worth hammering
Firstly, the constant leverage trap applies to inverse (-1X)
ETFs too. I once assumed only leverage factors greater than 1
resulted in the unexpected decay of returns. That's wrong. The
daily reset on single-exposure inverse funds results in exactly the
same effects, albeit muted compared with larger leverage factors.
It helps to see a concrete example.
Twelve-month returns of the Direxion Daily Small Cap Bear 3X
(in blue) and Direxion Daily Small Cap Bull 3X (in red).
Don't forget to check IndexUniverse.com's ETF Data
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