Leveraged ETF Trading Strategy (Backtest, Example Analysis)
Investors are always looking for ways to magnify their returns, and leveraged ETFs seem to promise that, which is why they are becoming very popular among both institutional and retail investors. Ever since their emergence, leveraged ETFs have received a lot of media attention that an uninformed may think they are all gains and no losses. What are leveraged ETFs, and what is a leveraged ETF strategy?
Leveraged ETF trading strategy refers to a short-term investment method that involves trading leveraged ETFs — exchange-traded funds that use financial derivatives and debt to amplify the returns of an underlying index. There are hundreds of leveraged ETFs across different asset classes and industry sectors, and they can be double-leveraged, triple-leveraged, or inverse ETFs.
This post answers some questions about the leveraged ETF trading strategy and how to trade it At the article’s end, we make an example and a backtest.
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What is leveraged ETF trading strategy?
Leveraged ETF trading strategy refers to a short-term investment method that involves trading leveraged ETFs — exchange-traded funds that use financial derivatives and debt to amplify the returns of an underlying index.
Unlike the traditional exchange-traded fund that typically tracks the securities in its underlying index on a one-to-one basis, a leveraged ETF may aim for a 2:1, 3:1, or an inverse of the index. Thus, there are hundreds of leveraged ETFs across different asset classes and industry sectors, and they can be double-leveraged, triple-leveraged, or inverse ETFs.
With a 3:1 or triple-leveraged ETF strategy, the aim is to return three times the profit the index makes in a day, but when there is a loss, it also magnifies it. An inverse ETF profits when the underlying index is declining and loses when the index is gaining. While the directly leveraged ETFs are used to aim for more profit in a bullish market, the inverse ETFs can be used to short the index in a bear market.