Leveraged ETFs have been designed for short-term traders who want to maximize the movements of certain market sectors, hedge positions and short the markets.  They are great tools that work exactly as they should for those who are educated and understand how they operate and what they’re for.

Leveraged ETFs are now getting a bad rap because some people who didn’t understand them used them and got burned in the process.

A recent regulatory filing indicated that 24% of ProShares UltraShort 20+Year Treasury (TBT), 11% of ProShares UltraShort S&P 500 (SDS) and about 9.7% of ProShares Ultra Financials (UYG) were owned by institutions, reports Daisy Maxey of The Wall Street Journal.

Does this mean that the remainder are owned by retail investors? According to ProShares LLC, these numbers are distorted because it doesn’t reflect institutional investors who don’t have to file a 13F with the Securities and Exchange Commission (SEC).

Regardless, retail investors make up a good chunk of those that utilize these investments and will have a significant impact on there future.

Meanwhile, the momentum against leveraged funds is gathering steam in Massachusetts, says On Wall Street. The state subpoenaed four brokers in order to get sales, revenue and training records. Those brokers are Ameriprise, UBS, LPL and Edward Jones, all of which in recent days have announced that they’re no longer selling those types of funds in response to FINRA’s warning. FINRA has since backed off its initial warning and noted that the funds can be appropriate for use by financial professionals.

Leveraged and inverse ETF providers all have addressed the issues and misperceptions about their funds that have cropped up in the last several months.

• Direxion noted that there is no one holding period that’s universally appropriate for leveraged and inverse funds. The products can be held for days, weeks or even a month or more, depending on the market, the investor’s view and goals.

• ProShares released their own study last month about the effects of compounding.

The bottom line is, before any investor chooses to buy these funds, they need to understand how they work. They’re not like other ETFs, but that doesn’t mean they’re bad. It’s also important to note that these funds are not for everyone, something even the providers have repeatedly stressed.

For more stories on leveraged and inverse ETFs, visit our long-short category.

Kevin Grewal contributed to this article.

Here is a list of them:

• UltraShort Semiconductor ProShares (SSG), which gained a whopping 113%
• UltraShort Technology ProShares (REW), which was up 98%
• UltraShort Russell MidCap Gr ProShares (SDK), which was up 96%
• UltraShort Russell 1000 Growth ProShares (SFK), which was up 83%
• UltraShort Individuals ProShares (SIJ), which was up 80%
• UltrsShort QQQ ProShares (QID), which was up 77%

Not surprisingly, all of these ETFs took a short position, in essence betting against the market. Among actively managed mutual funds, several short ones also did well, but none of them could touch the triple-digit returns of SSG.

This doesn’t mean that all ETFs performed well. Last year’s market left no sector untouched, and even the safe havens took a beating.  Some ETFs were down sharply, many in high double digits.

Another thing to keep in mind is that ETFs generally have larger Sharpe Ratios then mutual funds.  The standard deviation for mutual funds is 13%, meaning that most funds generated returns between negative 51% and negative 25%.  The standard deviation for ETFs is 27%, meaning that most ETFs generated returns between negative 65% and negative 11%, states Max Rottersman, principle at Hanover Tech Group for Index Universe.

It’s virtually impossible to predict the future and that’s why investors should educate themselves on all of their investments and make sure they don’t get taken to the cleaners.  If you are still worried about your portfolio, take a look at our ETF Analyzer to do some analysis and homework. And if you’re still in high-priced mutual funds, think about switching over to an ETF in a similar asset class.

Investors are always on the lookout for that new money-making deal that would help fill their lonely pockets with a fistful of cash, but those who choose incorrectly may have even lost the pants that those pockets were in.

According to John Spence for The Wall Street Journal, 2008 was not a kind year for traders investing in:

• SPDR S&P 500 (SPY): dropped 37%
• iShares MSCI EAFE Index Fund (EFA): dropped 41%
• PowerShares FTSE RAFI Emerging Markets Portfolio (PXH): dropped 45%
• ProShares Ultra Financials (UYG): dropped 85%
• iShares Dow Jones U.S. Home Construction (ITB): dropped 43%
• Commodities and material ETFs also took a beating. Most notably, oil ETFs and exchange traded notes (ETNs) that saw that drop of oil to below $40 a barrel. United States Oil Fund (USO) dropped 56%.

The important thing for investors to keep in mind is that some of the most beaten-down sectors will have the best opportunities for a recovery later. Some real bargains are lurking around the markets right now, so eye these funds and see if they move above their trend lines before you consider whether they’re right for you and your goals.

On the flip side, there are those lucky few who did not choose lemons in 2008 and profited with ETFs and ETNs such as:

• ProShares UltraShort S&P 500 (SDS), a leveraged, bearish fund designed to short the market, gained 61%.
• Long-term Treasury bonds sensitive to rate changes benefited from near zero Fed rate cuts. Vanguard Extended Duration Treasury ETF (EDV) gained 55%. iShares Lehman 20+ Year Treasury Bond Fund (TLT) gained 34%. SPDR Lehman Long Term Treasury ETF (TLO) gained 24%
• Currency ETFs that tracked the weakness of the dollar to other currencies also benefited. iPath JPY/USD Exchange Rate ETN (JYN) gained 23%. Rydex CurrencyShares Japanese Yen Trust (FXY) also gained 23%.

Overall, markets greatly shrunk in volume, but investors still continued to invest in ETFs. Market turmoil is also said to raise questions regarding ETNs and their innate credit risks for investors.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

According to a report on “ETF Liquidity Trends” filed by Deutsche Bank on July 22, inverse (short) and leveraged ETFs generated the third- and sixth-highest turnover levels respectively.

Paul Amery of IndexUniverse notes that in this same report by Deutsche Bank, there were 18 leveraged and 18 inverse ETFs in Europe, which represents roughly 2% of the European ETF market. This lags behind U.S. numbers, in which there are 45 inverse and 31 leveraged ETFs, combining for more than 4% of the U.S. ETF market.

Despite the domestic ETF market being larger than that of the European market, inverse and leveraged ETFs in Europe are not yet as prevalent as those in the United States for a number of potential reasons. In Europe, for one, there’s a relative lack of interest on the part of retail investors.

Regardless of the development of the European leveraged and inverse ETF sector being slower than this sector here, it is an area which is host to dynamic product development and increasing demand. Some long and short ETFs include:

• UltraShort Financials ProShares (SKF), up 33.1% year-to-date
• Rydex Inverse 2x Russell 2000 (RRZ), up 11.1% year-to-date
• Rydex 2x S&P Select Sector Health Care (RHM), launched July 22
• UltraShort Basic Materials ProShares (SMN), down 13.2% year-to-date
• Ultra Financials ProShares (UYG), down 50% year-to-date

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

For instance, the ProShares Ultra Oil and Gas (DIG) beefed up more than 60% through June since its early 2007 inception, only to lose 30% in less than one month’s time as oil prices slipped, reports Chris Bain for Associated Press

These types of funds retain their popularity because of their ability to make investors money, even in a down market. Money has been pouring into these ETFs as they aim to profit by taking sizable bets on a sector or the broad market using leverage. “Ultra” ETFs made up 6 of the 20 most actively traded ETFs, and each touted a daily volume above 10 million shares.

The short and ultra short ETFs are for short term hedges, and are not recommended for long term bets. The ETFs, which use futures and swap agreements, are easy to trade and can protect a portfolio. It is a good way to provide insurance without actually having to go short. They are useful for investors who do not want to sell a losing position but want to protect against further declines.

These ETFs have been successful, but they are not for everyone. Use them with caution and know when to quit. Other short and ultra short ETFs:

• ProShares Ultra Short Financials (SKF), up 24.2% year-to-date
• ProShares Ultra Dow 30 (DDM), down 88% year-to-date
• Rydex Inverse Russell 2000 (RRZ), up 5.8% year-to-date
• Rydex 2x S&P 500 (RSU), down 27.6% year-to-date

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.

Yesterday, financials continued to decline as Merrill Lynch (MER) shares dropped almost 10%, bringing the entire sector lower amid fears over credit quality and the housing sector.

Today, things are looking a little brighter, as most ETFs in the sector are up once again. For example, the Financial Select Sector SPDR (XLF) is up by more than 4% midday.

Over the weekend, U.S. lawmakers passed a rescue package targeted to help struggling homeowners and boost the confidence in mortgage giants Fannie Mae and Freddie Mac. However, as Elinor Comlay reports for Reuters, this bill will take time to go into effect and will more than likely not cure the housing crisis because of the many difficulties financials are facing.

Despite Congress passing this rescue package for Fannie Mae and Freddie Mac, the rest of the industry will be left fighting for themselves as the grim outlook for consumers and the economy persists. In talking with CNBC, Kathy Boyle expresses her main concern as simply being that we are not finished yet. She explains, “Wall Street would like to think that the worst is over , but we’ve been saying that for a while.”

As the current state of affairs in financials is ever-changing, some ETFs to cover both ups and downs a may be:

• Rydex Inverse 2x S&P Select Sector Financial (RFN), launched July 18
• UltraShort Financials ProShares (SKF), up 33.1% year-to-date
• Ultra Financials ProShares (UYG), down 50% year-to-date

Read the disclosure, as Tom Lydon is a board member of Rydex Funds.