Leveraged and inverse ETF pitfalls

I had a friend call the other day complaining about his ETF trade. In February of 2008 he bought QID which is an ETF that tracks 2x the inverse of the NDX, he is up 23% on his trade , but the NDX has declined 38% over this period and he should be up 2x that amount 76%. My friend is pissed because he way underperformed 2x the inverse of the NDX by 53% and left a lot of money on the table. There are a ton of other examples and Im sure most of you have your own horror stories. Check out the SKF ( 2x inverse of financial index) its down 22% since Nov 21 while the XLF is down 34% an underperformance of 78%. The SPY is down -48% since Jan 2008 but the SDS a 2x inverse S&P fund is only up 77% which is a 29% underperformance. The list goes on and on.

Want to know what to trade and when to trade? Click here

The best way that I can explain this underperformance of leveraged and inverse ETFs is that they are designed to track the underlying index based on a 1 day performance, these ETF’s wont track well over longer periods of time. As an example if we compare SPY vs SSO ( SSO tracks 2x the SPY ) lets assume both ETFs start at $100 per share and the SPY is up 10% to $110 and SSO is up 20% to $120 on day 1 , on day 2 SPY goes down 10% to $99 and SSO goes down 20% to $96. The 2 funds tracked well on a daily basis yet the 2 day return for SPY was -1% and SSO was -4%.

Below is a chart that shows the 1 day percentage change of QLD versus a 1 day percentage change of 2x the QQQQ. You can see that on most days the 1 day percentage change is very close.

The next chart shows how $100 would have grown in QLD since January 2008 versus how $100 using margin to buy 2 x the amount of QQQQ, margin interest was not accounted for. You can see that QLD and 2 x QQQQ track quite closely in the beginning then as time goes on the tracking widens.

Want to know what to trade and when to trade? Click here

My advice is that if you are going to trade the leveraged and inverse ETFs then trade them over a very short period of time. Let Ripe Trade back test your trading concepts , Click Here.

Subscribe to RipeTrade, details here!