Most individual investors and financial advisors stick to exchange traded funds that take long positions in the market and don’t employ leverage.
However, inverse and leveraged ETFs are often used by traders, and these volatile products generate their fair share of trading volume.
At the end of February, there was about $1.2 trillion in U.S.-listed exchange traded funds and notes, with the vast majority of assets concentrated in long funds. Leveraged and inverse funds accounted for about $33 billion, according to data from the ETF Industry Association.
Leveraged ETFs allow investors to magnify returns by 200% or 300%, usually on a daily basis, while inverse ETFs let traders speculate on market pullbacks and hedge.
Day traders can use leveraged and inverse ETFs to take positions while committing less capital, for example. Leverage ratchets up volatility, so these funds need to be monitored closely. [What You Need to Know About Leveraged And Inverse ETFs]
According to Goldman Sachs researchers, around 17% of hedge fund short positions and 4% of long positions were in ETFs. [More Hedge Funds Tap ETFs]
Inverse leveraged ETFs such as Direxion Energy Bear 3x Shares (NYSEArca: ERY) “offer active investors an excellent way to take advantage of market extremes to the upside without having to borrow shares in order to sell short,” writes David Penn at MarketWatch.
“A good idea with trading leveraged ETFs — inverse or not — is to reduce your standard trading position accordingly,” he added. “This will help keep your leveraged ETF trades from being disproportionately sized compared to your other, non-leveraged trades. So, for a triple leveraged ETF trade, reducing trading size to a third can be a prudent approach. With a 2x leveraged fund, reducing trading size by half is worth considering.”