You Can’t Stay Wrong for Long in SKF

Mar 24, 2009: 12:34 PM CST

A lot of newer traders are drawn to double (and triple) leveraged ETFs including the inverse side, but being on the wrong side of a trade can be financially devastating quicker than most traders imagine possible.  Let’s take a quick comparison of the recent moves in XLF (Financial SPDR ETF) and its double-leveraged inverse counterpart SKF.

XLF (Financial SPDR ETF):

The Financial ETF (XLF) has moved up over 60% from its March 9th bottom.  Look closely at the trend structure that preceded this move – we had a “Three Push” Reversal pattern (actually a ‘five push’ but there’s no such pattern, so maybe it’s best to call it a generic “multiple swing positive momentum divergence”) into the recent lows, which also formed a doji.  Odds certainly shifted at that point to favor a larger than normal counter-trend reaction, if not a pure trend reversal off that level.

Price managed to surge to break both the 20 and 50 day EMAs, and it now sits above both EMAs and – if it stays above these levels – a Cradle Trade will form which will be the impetus for an trend reversal.

What happened if you were ‘short’ the XLF going into this rally?  Or more specifically, what happened if you were long the SKF, which is a double leveraged inverse fund (also called a “juiced” or “supercharged short” fund)?  Let’s hope that didn’t happen to you.  But let’s see the chart anyway, and learn why you have to be very precise and elegant in your trades in this high-risk, high-reward fund.

SKF (Double Leveraged Inverse Financials ETF):

Assume you just had the worst timing possible and bought near $260 and rode the move all the way down to $100.  That’s also a 60% loss, but in price movement terms, it was more devastating than perhaps most newer traders expected.  That represented a dollar per share loss of $160, meaning if you got long 100 shares (a $26,000 position), then your shares you bought near $260 are now worth $100, or your account shows $10,000 for a $16,000 ‘unrealized’ loss.

If you look closely, the SKF made a new low not seen since September 2008.  Logic would imply that, for the SKF to be making new lows, the XLF must be making new highs but clearly that is not the case.  In fact, the XLF is down 60% from its September highs at $24.00 per share.

Think about that for a moment. If you bought the SKF (went 2x short the financials) at the September 2008 XLF price high at $24, and prices in the XLF have now fallen to $11 per share, take a look at your SKF position that you bought about $100 per share.  You were 100% correct in your assessment that the Financial Sector was going to fall hard – and it did.  However, as of today, you’re only back to break-even after a 60% fall in the XLF.

This is one of the serious pitfalls of leveraged ETFs – the rise is great, but the fall is worse than most people expect or can tolerate.  Among other reasons, this effect occurs due to the way percentages are reflected in price over time.

Without getting too technical, the moral of the story is this:

If you’re going to trade leveraged and leveraged inverse funds, you need to exercise tight risk controls, not give positions ‘room to run against you,’ cut losses as soon as possible (do not let your losers run), and treat them as very short term tactical trading vehicles. You may even want to consider a radically reduced position than normal.

If you can’t resist them, then juice up your returns when you’re right or have a strong opinion on a likely price direction, but when you’re wrong on a trade, exit immediately without hesitation.

Corey Rosenbloom
Afraid to Trade.com

Follow Corey on Twitter:  http://twitter.com/afraidtotrade
Register (free) for the Afraid to Trade.com Blog to stay updated

18 Comments

18 Responses to “You Can’t Stay Wrong for Long in SKF”

  1. Anonymous Says:

    Your misconception of return on September high of XLF. If you remember SKF paid a capital dividend

  2. Corey Rosenbloom Says:

    With that factored in, it still doesn’t explain the differential. From the more reasonable highs in XLF of $21 in Sept/October, SKF was at $100.

    With XLF currently at $11 (50% lower), SKF is at the exact same level.

  3. CastorTroy Says:

    They make it very clear in the prospectuses for leveraged ETFs that they are meant to track their index on an intra-day basis only and are not meant to be held for any extended period of time. That’s just the way the math works

  4. Corey Rosenbloom Says:

    Honestly, how many new traders read those prospectuses? And even if they did, how many would catch that?

    I’m really worried because if traders don’t educate themselves about these vehicles – which can be very rewarding – then they’re in for an unnecessary surprise.

    These are day-traders’ paradises – but are not meant for weekly/monthly swing trading and certainly not for position trading.

    I’m trying to help people understand that.

  5. p Says:

    good stuff corey

  6. Anonymous Says:

    i think you very well can trade this weekly/monthly. yearly no. but if you sense a trend their great

  7. Anonymous Says:

    and also corey the returns look much worse because the capital dividend was early on therefore each percentage gained should have been a tad more money. in nontrending markets these things go one way and that is down

  8. Corey Rosenbloom Says:

    Anon,

    It almost seems like it’s a deteriorating asset sort of like an option in a way, doesn’t it?

  9. Anonymous Says:

    Corey, have you done the math on SKF? It seems that it can possibly go below $1 on a large 50% (although very unlikely) move.

  10. Anon Says:

    Does SKF and UYG also track intra-day moves only? I thought only FAZ and FAS track like that.

  11. Corey Rosenbloom Says:

    Anon #9

    I have my own private thoughts on that scenario, but compare it to DXO, the double-long crude oil ETN. It hit $1.75 after oil’s stunning decline. People who buy in here thinking “well if crude’s going to go to $70 or so, then DXO is going to go to $10 or $20 or $30!” are just plain wrong. Short-term that is. Crude’s had a 40% move from $35 to $50 and DXO has had a – surprise – 50% move from $2.00 to $3.00.

    The problem is that when inverse ETFs suffer a large loss (or a big move in the underlying), their dollar value is slashed and so when they start to move up, they’ll do so on a percentage basis, but let’s not forget, a move from $2.00 to $4.00 is a 100% move, which would imply a 50% move in the underlying.

    I think most people aren’t aware of this phenomena.

  12. Corey Rosenbloom Says:

    Anon,

    I’m not super experienced in the double and triple fund world – as a rule, I avoid them (I trade index futures mainly) so I’m not entirely sure, but I would recommend visiting the respective ProShares (or other fund) homepage and reading the prospectus.

  13. Jim Chacona Says:

    I wonder if the same is true for 2x and 3x Bull [long] ETF’s? Your analysis is similar to Oleg’s more complex series featured on RealMoney. Both concentrated the analysis on the short etf’s.

    Basically is the FAS and other leveraged long ETF’s like UYG and TNA, etc. not a good long term positions? I also must point out the aforementioned long ETF’s also have DRIP [dividend re-investment].

    I realize one may suggest putting in reasonably tight stops, but I don’t want to trade these. I prefer to hold them as relatively long term investments.

    Your thoughts, Oleg?

  14. Jim Chacona Says:

    My bad – your thoughts, Corey?

  15. internet marketing Says:

    Low cost SEO, web marketing, internet marketing, web design & online advertising. Best SEO company for traffic.

  16. internet marketing Says:

    SEO, Web Marketing, Internet Marketing, Online Marketing, Web Design, SEO Company, Web Traffic, Low cost SEO, Low Price SEO, Online Advertising, Web Advertising, Internet Advertising, Search Engine Optimisation, Search Engine Optimization, SEO Firm, SEO New Zealand, Discount SEO, Cheap SEO, Affordable SEO

  17. Swing Trading Says:

    Interesting post. I have made a twitter post about this. Others no doubt will like it like I did.

  18. Swing Trading Says:

    Interesting post. I have made a twitter post about this. Others no doubt will like it like I did.