Leveraged ETFs: Should you trade them?

  • By Harrison Cole

  • October 10, 2018
  • 10:39 pm BST

Should you day trade, swing trade or make a long-term investment in leveraged ETFs? Four leveraged ETFs were approved by the SEC in 2006 after coming under scrutiny for many years. This should give you an indication of how serious the risks can be.

You can go long or short, and you can even find leveraged ETFs for underlying assets as diverse as cocoa, gas, silver and the 10-year Treasury. The ratios are usually 2:1 or 3:1. Like CFD trading, leveraged ETFs provide extra exposure to the underlying unit price of an investment vehicle in order to increase the pecuniary impact of price fluctuations.

The risk is high, with your money as well as that of the brokerage firm on the line. Unlike with CFD trading or forex leveraged trading, you are required to put down a minimum of 75% of the opening position. How exactly can you make money with leveraged ETFs? There are a number of defined ETFs strategies you can use, but one of the most common is to use regular day trading.

Leveraged ETFs: Day trading

Because of the borrowing limitations that brokerage firms place on leveraged ETFs, there is probably not much value in day trading them. You are usually better off trading hot share picks of the day. That way, you can still use the standard day trading margin of four times your cash on hand.

Consider the example of an average trading day on the S&P 500. The trading range, in all likelihood, is 2%. If you time your price movement well, you could net a potential 6% profit, but you are also likely to have chunks of cash tied up in the trade thanks to the margin requirements.

If you are day trading the sizzling stock of the day, however, the price swing could be 10% or more. That’s not what makes the stock more appealing; the real reason is that there probably won’t be special margin requirements. Not only can you trade this more volatile stock, but you can also pursue profits more freely by using more of your brokerage’s money.

Leveraged ETFs: Swing trading

Swing trading is a strategy used in CFD trading, but can it be used with leveraged ETFs? Can you time big moves in the market with a fair amount of precision? If so, you could be well-positioned to make swing trading ETF profits. Why would you want to swing trade ETFs as opposed to day trading them? The goal of trading in the first place is to make profits, and smart trading strategies help you make the most profits with less effort, or lower risk. In the day trading versus swing trading analysis, the effort required is probably the same, but the potential returns when you swing trade ETFs are far greater.

The potential problem with day trading ETFs is that you can make more money day trading stocks that are hot than you can with leveraged ETFs. This is due to two factors: narrower price range swings and stringent margin requirements that potentially tie up a lot of your cash. In swing trading, you can make big profits if you catch a vertical swing upward and don’t sell too quickly.

Leveraged ETFs: Long-term investing

The challenge here is that a buy-and-hold long-term strategy cannot be validated due to a lack of sufficient data. Moreover, the SEC has posted warnings explaining the dangers of investing in leveraged ETFs. The SEC issues day trading warnings, too, but there are sound calculations that support the long-term investment warning, particularly when it comes to underperformance.

When choosing between the three options, the best general trading advice is to avoid long-term investing and opt for swing trading if you can time big market moves accurately.