Tactical ETF Tools to Help Traders Better Manage Market Exposure

As we consider the road ahead for U.S. markets, investors can turn to tactical exchange traded fund tools to capitalize on the potential market shifts.

In the recent webcast, Q4 Fall Back or Ramp Up? A Trader’s Guide for the Road to 2022., David Mazza, Direxion’s managing director and head of product, explained that over the short term, traders can utilize leveraged and inverse ETFs for their highly tactical trading and hedging strategies.

The leveraged and inverse ETF marketplace is comprised of 171 ETFs with $70.7 billion in assets under management, covering differing levels of exposures and broad equity market segments, sectors, industries, single countries, and even fixed income and alternatives.

Leveraged and inverse tools for broad market exposures (primarily Nasdaq-100, S&P 500, and Russell 2000) dominate the marketplace, but there are over 25 sector products, 40 industry products, and almost 30 international products for whatever it is that traders are focused on, Mazza explained.

Mazza argued that the leveraged and inverse ETF marketplace provides tactical tools to access many different market segments with differing magnitudes of leverage. The tools magnify the returns of their benchmark index on a daily basis. Bull funds seek 200%/300% of the daily performance of the benchmark index while bear funds seek 200%/300% of the inverse of the daily performance of the benchmark index. They are designed to allow investors to gain additional exposure without the need for full dollar-for-dollar investment. These strategies are largely comprised of a combination of equity baskets and derivatives — typically swaps or futures contracts.

However, these tools are more complex in nature, and potential investors should still keep in mind that daily rebalance mechanics result in a unique set of drivers of performance when leveraged and inverse ETFs are held for periods longer than one day, especially in more volatile market conditions. The magnitude of leverage and daily rebalance design leads to notably different behaviors and results across different holding periods and market regimes. While these strategies can generate high returns during a strong rebound, they may also amplify losses if the markets swiftly turn. Consequently, potential users must consider the trend, as well as volatility, when utilizing leveraged and inverse ETFs, especially when the holding period is longer than one day.

Looking ahead, Gianni Di Poce, president of The Mercator, highlighted some themes that could potentially create short-term, tactical opportunities for leveraged and inverse ETF traders. For example, the dynamics between small- and large-cap markets, along with value and growth styles. The Federal Reserve’s bond purchases tapering and higher rate outlook could affect the yield curve. Also, hard assets could continue to strengthen on the secular bull market.

Tools like the Direxion Daily S&P 500® Bull 3X Shares ETF (SPXL), Direxion Daily Mid Cap Bull 3X Shares (MIDU) and Direxion Daily Small Cap Bull 3X Shares (TNA) could help investors track the shifts in equity market capitalization categories.

More focused plays like the Direxion Daily Energy Bull 2X Shares (ERX), Direxion Daily Regional Banks Bull 3X Shares (DPST) and Direxion Daily Industrials Bull 3X Shares (DUSL) could help investors access targeted market sectors as the economy continues to expand.

The Direxion Russell 1000 Value Over Growth ETF (NYSEArca: RWVG) could be one thematic play to capitalize on the potential shift from growth to value.

The Direxion Auspice Broad Commodity Strategy ETF (COM) can allow investors to access the ongoing rally in the commodities market as the global economy gains momentum and consumes more raw materials.

Traders can also look to inverse or bearish trading tools like the Direxion Daily 20+ Yr Trsy Bear 3X ETF (TMV), which seeks the daily investment results equal to 300% of the inverse of the daily performance of the ICE U.S. Treasury 20+ Year Bond Index, as a way to hedge against rising rates or falling bond prices as investors grow more anxious over the potential negative effects of a hawkish Federal Reserve and rising inflationary pressures.

Financial advisors who are interested in learning more about investment strategies for the environment ahead can watch the webcast here on demand.