Traders considering these ETFs should be aware that the inverse and leveraged products typically try to achieve their objective on a daily basis, and due to compounding of daily returns, the performance of the ETFs may diverge from the target return over extended periods, especially during volatile market conditions.
“When it comes to leveraged fund products that track daily results, their returns over time are the product of a series of daily returns,” according to Direxion. “They are not the fund’s leverage point multiplied by the cumulative return of the index for periods greater than a day. During periods of high volatility where markets lack a directional trend, returns can be impacted in a negative way should the funds be held for long periods.”
Compounding can affect leveraged ETFs differently in varying market conditions. For example, in an upward-trending market, compounding can result in long-term returns that are greater than the sum of the individual daily returns, according to ProShares. In a downward-trending market, it can show long-term results that are less negative than the sum of individual daily returns. However, the long-term results are less than the sum of the individual daily returns in volatile market conditions. [Leveraged ETFs Gain Popularity in Trending Markets]
For more information on geared products, visit our leveraged ETFs category.