Additionally, traders should know that inverse and leveraged products are not suitable for long-term buy-and-hold investors as the compounding affects from the rebalances would create divergences from the ETF’s performance to that of the underlying index, especially over periods of high volatility.
Fund sponsors have made it clear in their prospectus notes that leveraged ETFs try to pursue daily leveraged investment goals, and the returns of a fund for a period longer than a full trading day will not translate to a 200% or 300% return of an index for extended periods since the aggregate return of an ETF is based on a series of daily leveraged returns for each trading session as a result of “daily rebalancing”.
Nevertheless, leverage or inverse ETFs may be appealing for avid day traders. These funds tend to be very liquid and can be used as a hedge for any short-term corrections or upswings. Furthermore, these types of ETFs may be used to capitalize on positive current events that could provide a nice boost to the markets. Leveraged and inverse products also provide the opportunity for daily ETF traders to jump in and make some money on quick market actions or capitalize on pessimistic market news.
For past stories in this series, visit our “What is an ETF?” category.
Max Chen contributed to this article.