The trouble caused by the leverage and fees inherent in the diETFs is still a hot topic. Since it seems these ETFs make it even easier to lose money, I thought I’d discuss the money management strategy I use when I trade them.
I have a suspicion that many investors do not understand how the combination of leverage and volatility affects their returns. I hope common sense dictates to investors that they stand to lose money at least twice as fast as they would if they were not trading 2x leveraged vehicles. And while losing money twice as fast as normal seems more intuitively risky, I’m not sure that traders are using the money management techniques necessary to benefit from the leverage while simultaneously managing the risk and volatility.
I believe that investors are creatures of habit; thus, I think that it is likely most are using the same position sizes with these leveraged ETFs as they would with a common stock. (And why not? They trade just like a stock!) For example, an investor has an account worth 100K and spreads it across 10 stocks with 10K in each issue. The same investor may buy shares in a 2x leveraged ETF and use the same 10% capital allocation as he would if it were common stock. And why stop at one position? Why not allocate 50% across the various indexes and sectors available?
Money management techniques can be used to capture the volatility (assuming one is on the right side of the trade) and use the leverage of these ETFs while maintaining risk at levels expected without the use of leverage.
In Part 2 I’ll show the results of two different money management techniques applied to trade-by-trade sequences in SSO and SPY.
Part 2 is now finished: Money Management for Leveraged ETF Trading: Part 2
Obviously, I had not read the Fly’s position sizing post before I wrote this.
Had I, he would have been the perfect example of allocating position sizes for the diETFs the same as one would for common stock.
I don’t thimk anyone is that stupid Wood.
Its not stupid unless one doesn’t understand leverage and how volatility affects leveraged returns.
My assumption is that some people are trading these without fully understanding it.
Wood, I’m looking forward to part 2. I used the diETFs to both hedge and then take outright short positions during 2008 with results that were within my admittedly low expectations. Since I had long only accounts with long term gains that needed to be hedged I did not have a lot of options. I’ve yet to see a good analysis of how these instruments perform in various market conditions, just vague generalities about how bad they perform.
Yogi, a good short-term market timing system can turn these leveraged ETFs into money trees. I do not think they are good for much of anything else other than trading and holding short-term (1 to 3 weeks maximum).
If they are to be held for longer periods, I recommend shorting them all, both the long and the shorts.
By the way, part 2 is finished.