The Average Investor's Blog

A software developer view on the markets

The Weekly Update

Posted by The Average Investor on Jan 30, 2011

Asset Symbol Position Date In Gain
Nasdaq 100 ^NDX Long 2010-09-03 21.40%
S&P 500 ^GSPC Long 2010-09-30 11.84%
US REIT VNQ Long 2010-07-23 12.98%

Friday was a huge down day, which turned a good week into a no-change week. There was another interesting development – we closed one of ours long term positions. The Emerging Markets gave a sell signal at the close on Friday. This position (opened July 23, 2010) was a winning one for a 10% gain. At some point the gains were as high as 18% so using a stop-gain or a trailing stop-loss one might have a achieved better results.

There is a better way to improve the gains though – using a leveraged ETF. Wait a minute, but isn’t it “common” knowledge that leveraged ETFs must not be used for leveraging, especially for long term positions? Many experts, including Mebane Faber, warn of the dangerous of such an approach?

In general, that’s true, as usual however the devil is in the details. At first, I myself was quite surprised by my observations.

The statement I am trying to make is that in my experience and experiments, quite often, leveraged ETFs seem to give the “expected” long-term leveraged performance over long term, but only WHEN COMBINED with a trend-following strategy. In other words, one does not expect a 3x ETF to grow exactly three times more than the underlying index over a randomly selected period of time (for instance think of a randomly selecting a three month period), however, this happens often when the entry and exit points are determined by a successful trade of a trend-following strategy.

The trick in my opinion is the combination between a trend following technique and a leveraged ETF. A plausible explanation might be that when we “catch” the trend, typically there will be more positive days and more moves to the upside. Thus, the negative impact of negative days is greatly diminished and we see a decent leveraged results with no other cost but the higher risk.

For this position for instance, using EDC, which is a 3x bull ETF on the same underlying index, one gets a gain of 27.79%, which is damn close to perfection (30%). Even better performance by EET, which is a 2x bull ETF on the same underlying index – 21.08%.

THIS IS NOT A RECOMMENDATION TO USE LEVERAGED ETFs IN THIS PARTICULAR MANNER, but yet another observation of how following “common” knowledge might be missing on significant opportunities. From now on, let’s keep an eye on the performance of the leveraged vehicles as well.


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