TRADE LEVERAGED ETFS THE RIGHT WAY
Leveraged ETFs, although easy to trade, can be extremely complicated and volatile. Hence, it is not advised to be complacent when trading this tricksy investment. Read on to avoid some of the common mistakes in trading leveraged ETFs.
Enabling leverage to cloud sector exposure. Knowing the worth of each sector enables a trader to gauge the appropriate asset allocation within a portfolio. However, the exposure can be greater than initially projected when leveraged fund have underlying sectors.
Failure to determine time and loss limits. Negative compounding is one of the most taxing trading experience. Even if you are on the right track, you still lose money in the process. A trader may believe an ETF is going to keep up with the pace of its index. However, that is not the case. Traders need to set the time period for owning a leveraged ETF and the amount they can afford to lose. Remember that the longer a leveraged fund is possessed, the higher the loss will be due to negative compounding.
Dismissing the impacts of rebalancing to funds. Majority of leveraged ETFs are rebalanced daily. But do not ignore how it can impact the fund’s performance if prices are flip-flopping or going against the ETF. Do you rebalancing aggravates the loss you can incur? It is because the holdings must be lowered to reflect three times leverage on the closing price of the shares for a given day.
A higher percentage is also required to break even in the following days, with lower exposure due to downscaled rebalancing. The effects on performance because of such a rebalancing makes funds work better unlike short-term derivatives.
Purchasing on margin. Leveraged ETFs are literally leveraged. So why buy on margin? A leveraged fund is already volatile in nature, and integrating margin can make it more erratic. For instance, if losses continue, the initial equity in a position would be wiped out upon hitting a 25% loss against the ETF’s index. To make things more complex, a loss higher than 25% could place a position at a negative territory.
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