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There is a wide range of leveraged strategies available to retail investors. Many of these strategies mimic the performance of major indexes, while others focus on specific sectors such as semiconductors and biotech. Through leveraged strategies, investors aim to generate additional returns by utilizing debt.
Understanding leveraged trading
Leveraged trading allows traders to use borrowed funds to increase their buying power. By borrowing money and purchasing additional shares of an investment, investors can potentially earn more than if they had only used their available cash. However, this strategy comes with increased risk, as losses can be magnified when trades do not go as planned. Additionally, traders must repay the borrowed funds along with any interest and fees.
It is important to note that traders are also subject to capital gains taxes if the assets are held in a taxable account.
Leveraged ETFs: A guide to their operation
Leveraged exchange-traded funds (ETFs) utilize leverage to enhance the potential returns on major indexes like the S&P 500. These funds utilize financial derivatives to amplify the fund’s performance. For example:
- If the benchmark index increases by 1 percent, a standard S&P 500 index fund would also see a similar 1 percent increase. However, a leveraged ETF may aim to increase that daily performance by two or even three times.
- When the S&P 500 rises by 1 percent, a leveraged ETF tracking the index could see a 2 percent or 3 percent increase, depending on the level of leverage employed.
While the potential for higher returns may seem appealing, the potential losses are equally significant. In the example above, if the stock market decreases by 2 percent, a triple-leveraged ETF could decline by around 6 percent, based on the underlying assets.
It is important to understand that leveraged ETFs are designed to enhance the daily performance of specific market indexes. Therefore, these funds are not suitable for long-term investments and should be used by short-term traders only.
Top leveraged ETFs
Here are some of the most popular leveraged ETFs as of August 12, 2024:
ProShares UltraPro Short QQQ (SQQQ)
This highly leveraged ETF provides three times downside exposure to large-cap, tech-heavy companies in the Nasdaq 100 index. The average daily trading volume for this ETF is approximately 148 million shares, making it one of the most popular leveraged funds.
- Expense ratio: 0.95 percent
- Assets under management: $2.6 billion
ProShares Ultra S&P 500 (SSO)
This fund offers two times daily upside leverage exposure to the Standard & Poor’s 500 index. The average daily trading volume for this ETF is around 2.9 million shares.
- Expense ratio: 0.91 percent
- Assets under management: $4.6 billion
ProShares UltraPro Short Dow30 (SDOW)
This ETF provides three times downside leverage exposure to the Dow Jones Industrial Average. The average daily trading volume for this ETF is approximately 15.7 million shares.
- Expense ratio: 0.95 percent
- Assets under management: $293.4 million
Direxion Daily Small Cap Bull 3X Shares (TNA)
This fund offers three times leveraged upside exposure to small-cap companies in the Russell 2000 index. The average daily trading volume for this ETF is around 19.5 million shares.
- Expense ratio: 1.08 percent
- Assets under management: $2.4 billion
Direxion Daily Small Cap Bear 3X Shares (TZA)
Conversely, this fund provides three times leveraged downside exposure to small-cap companies in the Russell 2000. The average daily trading volume for this ETF is approximately 24.1 million shares.
- Expense ratio: 1.04 percent
- Assets under management: $329.7 million
Direxion Daily Semiconductor Bull 3x Shares (SOXL)
This ETF offers three times leveraged upside exposure to an index of companies involved in the development and manufacturing of semiconductors. The average daily trading volume for this ETF is about 68 million shares.
- Expense ratio: 0.76 percent
- Assets under management: $10.3 billion
ProShares UltraPro QQQ (TQQQ)
This fund amplifies exposure to the tech-heavy Nasdaq 100, aiming to provide traders with three times the daily movement of that index. The average daily trading volume is approximately 54.3 million shares.
- Expense ratio: 0.88 percent
- Assets under management: $20 billion
Direxion Daily S&P 500 Bull 3x (SPXL)
This ETF seeks to provide three times the daily return on the S&P 500, which can increase rapidly in a strong bull market. The average daily trading volume is 4.4 million shares.
- Expense ratio: 0.91 percent
- Assets under management: $4.1 billion
Purchasing leveraged ETFs
Leveraged ETFs can be beneficial for experienced traders as heightened volatility presents short-term opportunities to profit from trades. Additionally, with inverse leveraged ETFs that allow traders to profit from market declines, traders can potentially earn even when the market is falling.
For example, the ProShares UltraShort QQQ ETF (QID) aims to provide twice the inverse performance of the Nasdaq 100 index. Therefore, if the benchmark index decreases by 2 percent, this ETF is expected to increase by approximately 4 percent.
During periods of increased market volatility, these speculative investments can be lucrative.
When considering leveraged ETFs, it is important to assess your financial situation and risk tolerance. These funds can play a significant role in your trading strategy, but it is crucial to have a solid understanding of your financial knowledge and engagement with your investments.
Investors should approach leveraged ETFs with caution, as these instruments can amplify both gains and losses. It is advisable to start with a small allocation in these risky assets and have an exit strategy in place. Consistency in following your plan and knowing when to exit a losing position are key factors for success.
Factors to consider when investing in leveraged ETFs
Traditionally targeted at sophisticated investors, leveraged trading has gained popularity among retail investors in recent years. Driven by the allure of quick profits, many individuals have turned to leveraged ETFs as a way to participate in the market.
Leveraged ETFs are a unique investment type that seeks to amplify returns through the use of financial derivatives and debt. Essentially, they are ETFs with enhanced performance potential.
There are various screening tools available to identify these funds, including those offered by numerous brokerage firms. While factors such as management fees and historical performance are essential considerations, it is crucial to thoroughly review the fund’s prospectus.
A prospectus serves as a legal document that outlines the fund’s investment strategy. By carefully reviewing this information before investing, you can determine whether the fund’s approach aligns with your investment objectives.
As you narrow down your choices, key features to evaluate include:
- Leverage: This metric is expressed as a number followed by the letter “x.” For instance, a fund like the Direxion Daily S&P 500 Bull 3X Shares (SPXL) offers three times the performance of the S&P 500 index. It is important to note that the leveraged return is based on a single day’s performance and not cumulative over time.
- Expense ratios and fees: While most ETF providers offer competitive fees, these costs can accumulate over time. Therefore, it is essential to compare fees and carefully review the terms.
- Trading volume: The liquidity of a fund affects its ease of buying and selling. Comparing the average trading volume to similar ETFs can provide insights into liquidity.
- Fund performance: When conducting research, it is beneficial to examine a fund’s longer-term performance. However, it is important to remember that these funds are not intended for buy-and-hold strategies.
- Assets under management (AUM): Many investors view AUM as a measure of confidence, indicating other investors’ engagement with a specific ETF. In addition to AUM, assessing the fund’s longevity can be informative.
- Fund issuer: The reputation of the fund issuer can influence investor decisions. Some investors prefer established asset managers, while others may be open to newer players in the market. Determine what aligns with your financial preferences and needs.
Utilize these criteria as a foundation for further research. Some investors find it beneficial to monitor the daily performance of leveraged ETFs before committing capital.
Editorial Disclaimer: It is recommended that all investors conduct independent research on investment strategies before making decisions. Furthermore, past performance of investment products does not guarantee future price appreciation.