Over the past few weeks, the financial sector has made a run, but the levered versions of this sector and its exchange traded funds (ETFs) have truly defined the affects of compounding.

Since March 9, the Russell 1000 Financial Services Index has gained nearly 62% on positive news from analysts and improving economic data.  Now compare that to a more concentrated fund that tracks the financials, the Direxion Financial Bull 3X (FAS), which has returned a whopping 260% over the same period.  This fund is designed to return three times what a financial index would return, which it has done and thus makes it attractive to riskeir investors.

On the contrary, the inverse version of the aforementioned index, the Direxion Financial Bear 3X (FAZ), has plummeted close to 90% over the same period.  It is fairly obvious how compounding works and volatility can influence the returns of these levered ETFs, states David Gaffen of The Wall Street Journal.

Despite the continuous volatility in levered ETFs, they are still becoming more popular.  Perhaps it is because these ETFs enable investors an easy way to take leveraged long or short bets on a sector.  There are, however, plenty of opponents of these volatile investing tools.  The truth is that these tools work exactly as they’re supposed to.

As with everything else, the more concentrated the ETF is, the more volatile it is.  It’s the same concept of keeping all your eggs in one basket.  For this reason, we recommend that you remain diversified and have a strategy, such as the 200-day moving average strategy.

Share your thoughts about leveraged ETFs in our forums.

Kevin Grewal contributed to this article.

Tags: ETF 101, FAS, FAZ, Financial, Long-Short ETFs, Sector ETFs