What Is a 3x Leveraged ETF And Why Do I Trade Them?


What is a 3x leveraged etf?

I wrote a blog back in February of this year explaining what an ETF is. If you don’t know what an ETF is start here: https://www.followmytrades.co.uk/post/what-is-an-etf


On the face of it ETF’s like $TQQQ $SPXL and $FNGU are no different to any other ETF. They hold a basket of securities in one wrapper allowing you to own a piece of multiple companies in one trade.


The major difference is these ETF’s use leverage. Three times leverage in fact. In this blog I will go over the pros and cons of trading 3x leverage ETFs and some of the myths that surround them.


I’ve been trading 3x ETFs for a long time. I was trading back in the days of 500:1 leverage so 3:1 doesn’t scare me! However, it may unnerve some people and for good reason.


Let’s take $SPXL for example. The $SPXL is designed to move 3 times more than the $SPX in a single day. So if the $SPX moves up 1% the $SPXL will move up 3%. Simple, right? Well, not quite. Although you will get the ‘daily’ gain/loss of 3x the the index it is tracking; over the long term it doesn’t quite work like that.


If we take $TQQQ vs $QQQ as an example and look at the last 12 months gains (low in September 2020 to the high September 21). The $TQQQ has gained over 180% whilst the $QQQ has only gained 47%. In the bear market in March 2020 the $QQQ lost 30% whilst the $TQQQ lost just over 70%. This is due to a number of factors including compounding, decay and re-balancing. The ETF is rebalanced daily so over long periods of time (months/years) the performance of the fund will not be correlated. Please note, this can work both ways, so if we see a prolonged bear market your losses on a 3x leveraged ETF could be even more pronounced. In long term choppy markets you can lose money even if the underlying index is flat.


Returns


Over the last 10 years the $QQQ has returned on average 20% per year. The $TQQQ has returned on average 60% per year.


$1000 in $TQQQ 10 years ago would be worth over $116,000 today.

$1000 in $QQQ 10 years ago would be worth around $8000 today.


That’s a pretty big difference and it will explain why people are attracted to leveraged ETFs.

Pros & Cons


Pros


  • In a bull market your gains will far exceed the benchmarks.

  • You can’t lose more than your original investment unlike using traditional leverage or margin

  • Huge trading volume = liquidity

  • Highly unlikely the ETF will go to zero as it is basket of companies.


Cons


  • Higher than average management fees

  • If the underlying market crashes more than 33.4% in a day the fund will collapse

  • In side ways moving markets you can lose money as opposed to the underlying index being flat, this is due to daily rebalancing.

  • Losses can be compounded in prolonged bear markets

  • High volatility - If you can’t handle deep red don’t trade it

Conclusion

The reason I’m writing this is because there are a lot of negative blogs online about leveraged ETF’s. They always talk about ‘what if the market crashes’ or ‘time decay’. They rarely talk about the realities of the prolonged bull markets we have seen and how these ETF’s have far out-performed virtually every stock market investor on the planet. If we continue to believe tech is the future there is no reason for ETF’s like $TQQQ $SOXL and $FNGU to perish.


Yes, there is risk, let’s face it the whole stock market is a casino! But, as a fairly young(ish) person I have time for my portfolio to ride out any bear markets or sharp crashes. If I was knocking on the door of retirement would I be buying leveraged ETFs? Probably not. But for now I will continue to dollar cost average into these ETFS for the next 20 years.


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