When I first discovered leveraged ETFs, I was excited to say the least. Leveraged ETFs are designed to double or even triple the returns of an underlying index. Meaning that if the S&P Biotech Index (SPSIBI) goes up by 2% today, the 3X Leveraged ETF, $LABU, will give you a 6% return. The high volatility of these stocks can provide high returns for day traders if a good technique is developed and discipline is exercised. These ETFs work just like a stock. They can be bought, sold, shorted and you can do options on them during market and after hours.
Leveraged ETFs that are labeled “BULL” are meant to follow the direction of the underlying exchange. ETFs that are labeled “BEAR”, also called inverse ETFs, are meant to follow the opposite direction of the underlying exchange. While in theory that means that if the BULL is going up then the BEAR is going down, that is not always the case. They also do not fall and rise at the same pace. So while the BULL may have risen 6% the BEAR may have fell by 10%.
There are hundreds of leveraged ETFs out there. The ones I have on my watch list 24/7 are $LABU, $SVXY, $UVXY, $JNUG and $JDST. $SVXY and $UVXY follow the Global Volatility Index, VIX. $JNUG and $JDST follows the Global Junior Gold Miners Index, MVGDXJTR. The market and trends for the underlying index of these leveraged ETFs are what you want to understand when trading them. While developing different strategies I came up with 3 rules that I abide by when trading these securities.
1. Never hold for more than a week or over the weekend
Leveraged ETFs are meant for daily returns. They should not be used as long term investments. Even if the ETF seems to be increasing significantly over time, the high expense ratio that comes with leveraged ETFs may eat away at your profits the longer you hold. Also, if the trend changes out of favor for the underlying index of your leverage ETF then your losses will outweigh your profits.
2. No Trades Before 10:30 AM
Most leveraged ETFs are designed so that they re-balance each day before following the trend of their specific index. I find that waiting until 10:30AM lets the ETF re-balance. Also, as a general rule of thumb, I do not trade within the first hour of the market opening because I have noticed that I cannot properly gauge which direction the market is going in order for me to make and accurate trade.
3. Charts are the number one resource
The daily returns on a leveraged ETF are based off of the underlying index of the stock. While different trends in that particular index can give you an idea of how much the ETF will return for the day, charts are your best friend. The charts will let you know when there is a sign of reversal, which will signify when you need to buy or sell the security. So even though $LABU might usually bottom out in the low $70 range, if the chart shows that it is going to empty out at $65 then wait before hopping in.
Leveraged ETFs are risky and should not be done without proper understanding of the trends of the underlying index. But given enough research and experience, they can yield high rates of returns for day traders.