Extreme Volatility in Leveraged SKF

Nov 25, 2008: 11:56 AM CST

During the Financial Crisis of 2008, the Ultra-short (two times leveraged) Financial ETF – symbol SKF – has generated a grand profit for some traders.  However, such grand profits are not without extreme risk, as we saw in the recent three-day 50% slide in the ETF.  Let’s look at this development and add a little reality to trading leveraged funds.

SKF (Ultra-Short Financials) Daily:

Ahh, the beauty (and curse) of leveraged funds.  For each corresponding 5% move down in the Financial sector (XLF), we would expect to see a 10% move UP in the ultra-short (2x leveraged) SKF.  But what happens when the Financial Sector (XLF) rallies 25% in two days?  Absolute disaster for investors in SKF.

There was a massive sell-off in Financial stocks throughout November as economic uncertainties continued, but we’ve seen concerted efforts with the New Administration as well as the current Treasury and Fed officials attempting to reassure shaky markets.

As such, Financial Stocks – such as Citigroup especially (C) – have rallied quite nicely.

Of course, with every bit of good news in the market, there is the ‘other side’ of the trade, and in this case those who were short financial companies – or long the SKF (inverse fund) – bore the brunt of the last couple of days of the market rally.

SKF just fell from a peak of $300 per share last Friday to (as of today’s) an intraday low of $152 for a 50% decline in just under three days’ time.

Let’s zoom in to the 30-minute chart to see this development a little closer.

SKF (Ultra-Short Financials) 30-min chart

I’m showing a few positive and negative momentum divergences which set-up throughout the course of part of this rally in SKF which was finished with a clear negative divergence going into Friday’s action.  There’s currently a positive divergence setting up which could lead to a challenge of the $180 or perhaps $190 area, but let’s take that day-by-day to see how it officially plays out.

For a bit of fun and practice, I wanted to share my interpretation of a possible completed Elliott Wave impulse – complete with each wave broken down into fractal waves – of the move throughout November in SKF.

Complete Elliott Wave Impulse with Fractals:

This is a near text-book Elliott pattern (in my humble interpretation) with each fractal wave obeying the main Elliott principles as well.

Wave 1 was extended in the impulse with Wave 3 being roughly equal to Wave 1.  Wave 5 was the shortest in this case.

Remember that with great reward comes (or accompanies) great risk, and though you can make money very quickly with inverse or leveraged inverse funds when the Financial sector is selling off, you can lose it just as quickly (or – in this case, far faster) when price reverses and you don’t honor your stops or money management parameters.

Corey Rosenbloom
Afraid to Trade.com

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