The Evils Of Leveraged ETF's and Those That Suggest Them
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
As some of you may know me by now, I run a trading room with over 3500 traders, have over 450 money manager clients, have over 23,000 followers on Seeking Alpha, and have the 6th largest service out of the 169 that are offered in the Seeking Alpha Marketplace (even though I am a technical analyst on that fundamental analysis web site). I have certainly come a long way since I first opened the doors to my trading room a little over 6 years ago.
During the 6 years I have been running my trading room, I have seen what traders do right and what traders do wrong. One of the biggest pitfalls I have seen that trip traders and investors up is the inappropriate use of leverage.
As an investor or trader, you have a responsibility to yourself and your family to preserve your capital. That means one needs to always maintain an appropriate risk management plan, which means you MUST know your entry, exit and stop-out level even before you enter a trade. It also means avoiding the inappropriate use of leveraged instruments.
Anyone with any experience understands that leverage is a double edge sword. When one knows how to appropriately use it, it can turbo-charge returns. But, when one does not, it can take you to the poor house. And, while most people are smart enough to stay away from options if they do not understand them, too many still use leveraged ETF’s. But, most people also do not understand how these leveraged ETF’s work. And, that includes analysts.
Unfortunately, leveraged ETF’s are designed in such a way that if you are not catching a strong trending move perfectly, they will lose money. Even if the market is moving sideways, these leveraged ETF’s lose money. And, if the market moves down, well, they lose money twice or three times as fast. So, unless you are able to time the market absolutely perfectly, then you should NEVER, EVER, EVER buy and hold one of these instruments. They are designed to be a trading vehicle and nothing more.
Yet, greed often gets the best of many investors, which makes these leveraged instruments look so enticing.
Moreover, analysts who want to turbo-charge the returns they can publicize to bring in new subscribers will also gamble on the use of these leveraged instruments. And, yes, I am using the word “gamble” appropriately in this instance, as that is what they are doing with your money when they tell you to buy-and-hold leveraged ETF’s, while promising you the path to untold riches.
I have not yet seen a single instance where subscribers do not blow up their accounts when following an analyst who consistently advises a buy-and-hold strategy using these leveraged ETF’s. I can assure you that those analysts care much more about their win rate than they do about your investment account. In fact, I have seen one analyst that has deleted their model portfolio many times when they have blown up due to inappropriately timed use of these leveraged ETF’s. In this way, he has been able to begin gambling with subscriber’s money all over again, so that he can advertise 500% returns in the last 3 months. Yet, he has blown up accounts each and every year for the last several years.
Let me give you an example. There was a “call” by an “analyst” I saw in 2016 which suggested to buy AND HOLD a metals 3X ETF when it was around 25, without any stops, and using much more than 25% of your portfolio. In fact, this analyst did exactly what most amateurs do – they buy at just about the high of the market in an oversized position because they have been sucked in by the market sentiment. In other words, he was simply part of the herd being led to slaughter. And, he backed up his call by promising those who take his suggestion will be wealthy beyond their wildest imagination.
Sadly, for those investing their hard-earned money based upon that “call,” that 3X ETF hit a low of 3.77 only a few months later. For those counting, that is an 85% drop in price in a few months, and it was catastrophic to those who followed this call. Moreover, based upon the way these 3X ETF’s are calculated, the underlying market will have to rally significantly higher than the point at which this “investment” was made in order for those who bought into this suggestion to even break even.
Clearly, this “analyst” has not learned from his massive failures, as he has recently done it again to his subscribers. This time, he supposedly suggested a “buy and hold” on a 3X TECH ETF (TQQQ) just as the market was hitting its highs. And, again, he promised riches beyond their wildest imagination to those foolish enough to follow him. Unfortunately, these investors are now experiencing a whole lot of pain at this time.
So, please allow me to highlight some of the rules to which you always want to adhere in order to protect your capital over the long term, and avoid blowing up your account.
First, one should NEVER buy a 3X ETF as an investment, as it is a trading vehicle and not a buy-and-hold vehicle. Any knowledgeable advisor or market analyst should know this, and if you see an advisor suggesting otherwise, PLEASE recognize that he is suggesting that you gamble with your money.
Second, anytime you enter into trade or investment, you MUST know your entry, exit and stop out level BEFORE you even enter the trade or investment.
Third, you should never place all your eggs or even the majority of your eggs in one basket. Personally, I suggest that investors not use more than 3-5% of their account on any single product or stock.
Again, each and every one of you have a responsibility to yourself, your future, and your families’ future and should not be taking needless risks in an already difficult financial environment. If you follow some simple risk management strategies, and stay away from 3X ETF’s for investment purposes, you give yourself a much better chance of finishing this marathon by avoiding any catastrophic set-backs, from which it could take years to recover.
Since it does not seem as though regulators are protecting the public from analysts like the one noted above. That means it is incumbent on each and every one of you to be responsible for your own trades and investments. And, if someone is suggesting overly aggressive positions utilizing leveraged products for a buy-and-hold scenarios without any risk management plan in place, I would be running for the door as fast as I can, as it is clear that this person does not have your best interest at heart.