Harry
06-17-2011, 06:25 AM
I am sure majority of the group here already knows this, but yesterday I was speaking with a friend who has over 20+ years of personal trading experience and much to my surprise he was not aware of this issue. So, I thought why not take a second to burn a thread and remind those who don’t about the limitations of leveraged (2X & 3X) instruments.
I am sure almost everyone has heard that leveraged instruments should not be considered for buy-and-hold but rather utilized for day-trading only. Why? For this example, I am going to use round numbers and extreme moves to prove the point. In a perfect world, leveraged instruments are intended to magnify the close of the instrument by 2X or 3X (yes, I am aware that prices are driven by liquidity, bids and asks, etc. yet the underlying principle remains).
Let’s pick a hypothetical index and start with $20K, where $10K will be placed in an account for a +2X ETF and $10K will be placed in an account for a +3X ETF.
On Day 1 of holding, if the index INCREASES by 5%, the 2X account will be worth $11,000 and the 3X worth $11,500.
On Day 2 of holding, if the index DECREASES by 5%, the 2X account will be worth $9,900 and the 3X worth $9,775.
So, after two days, the index is back to where it started (0% change after 2 days) and yet your principal is less.
You might be asking yourself, what if the index moved in reverse directions.
On Day 1 of holding, if the index DECREASES by 5%, the 2X account will be worth $9,000 and the 3X worth $8,500.
On Day 2 of holding, if the index INCREASES by 5%, the 2X account will be worth $9,900 and the 3X worth $9,775.
Again, the index is back to where it started and your principal is less.
What’s the moral of the story, leveraged instruments are dangerous to your principal in a sideways market. Full disclosure, I am guilty of the above as I also hold TNA since last Friday.
So my goal here is to provoke some thoughts and possibly develop a trading strategy. My question to the group is “is there a better strategy to minimize risk when one wishes to leverage positions when the Robots issues ‘very strong’ signals?” Pascal has already talked about how the 20DMF is an early signal. Should we divide money allotted for the robot signals into thirds and used the 20DMF for the first 1/3 in a 1X instrument. Options are another way to capture leverage but I must admit I don’t know much about options. Paul Duncan’s methods seem promising (slope of slopes to confirm market trend) and maybe these should be utilized for the final 2/3 of the principal if one wished to add leverage (2X & 3X) positions? I have questions but no answers. Any ideas?
Harry
I am sure almost everyone has heard that leveraged instruments should not be considered for buy-and-hold but rather utilized for day-trading only. Why? For this example, I am going to use round numbers and extreme moves to prove the point. In a perfect world, leveraged instruments are intended to magnify the close of the instrument by 2X or 3X (yes, I am aware that prices are driven by liquidity, bids and asks, etc. yet the underlying principle remains).
Let’s pick a hypothetical index and start with $20K, where $10K will be placed in an account for a +2X ETF and $10K will be placed in an account for a +3X ETF.
On Day 1 of holding, if the index INCREASES by 5%, the 2X account will be worth $11,000 and the 3X worth $11,500.
On Day 2 of holding, if the index DECREASES by 5%, the 2X account will be worth $9,900 and the 3X worth $9,775.
So, after two days, the index is back to where it started (0% change after 2 days) and yet your principal is less.
You might be asking yourself, what if the index moved in reverse directions.
On Day 1 of holding, if the index DECREASES by 5%, the 2X account will be worth $9,000 and the 3X worth $8,500.
On Day 2 of holding, if the index INCREASES by 5%, the 2X account will be worth $9,900 and the 3X worth $9,775.
Again, the index is back to where it started and your principal is less.
What’s the moral of the story, leveraged instruments are dangerous to your principal in a sideways market. Full disclosure, I am guilty of the above as I also hold TNA since last Friday.
So my goal here is to provoke some thoughts and possibly develop a trading strategy. My question to the group is “is there a better strategy to minimize risk when one wishes to leverage positions when the Robots issues ‘very strong’ signals?” Pascal has already talked about how the 20DMF is an early signal. Should we divide money allotted for the robot signals into thirds and used the 20DMF for the first 1/3 in a 1X instrument. Options are another way to capture leverage but I must admit I don’t know much about options. Paul Duncan’s methods seem promising (slope of slopes to confirm market trend) and maybe these should be utilized for the final 2/3 of the principal if one wished to add leverage (2X & 3X) positions? I have questions but no answers. Any ideas?
Harry