Friday, March 7, 2014

Leverage


I make money on stocks mostly by shorting leveraged ETFs. It has sometimes been said that all leveraged ETFs go to zero given enough time. That's not entirely true unless enough time is an awful long time. Here's an interesting article on the subject:

http://ddnum.com/articles/leveragedETFs.php

Leveraged ETFs can be held long term provided the market has enough return to overcome volatility drag. It usually does. For most markets in recent times the optimal leverage is about 2. But some markets and time frames will reward a leverage of up to 3. No markets will reward a leverage of 4.
 It's not as easy as picking a leveraged ETF to short and then holding on. Timing is essential, and volatility drag higher than return is needed. That's why shorting inverse leveraged ETFs are superior to shorting long leveraged ETFs. Markets tend to go up over time and if the go down they do so in a more volatile pattern. In markets where there is a lot of volatility, like natural gas, it is safer to short the long leveraged ETFs then it is in low volatility markets, however it will always be prefered to short inverse leveraged ETFs. Most important of all there has to be a technical setup, a more or less educated guess about the future direction of the ETF. That is where the blow of top pattern and the related testing of resistance pattern helps.

To summarize. 1. Find the technical setup 2. Weigh the technical setup against A, expected volatility and B, the direction of the leveraged ETF (inverse to be prefered). If it looks good then trade it and always leave some ammo dry for even better setups.


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