Don't Bite The Hand That Feeds You

[TheInvisibleHand ™]

email sent Good article on ETFs Hazardous To Your Wealth?




Good article on ETFs Hazardous To Your Wealth?

Back in 2006 when QID and QLD debuted I read all over the Net that one would make (or lose) 2x the movement of the Nasdaq 100 ($NDX)...Since that time both are down from their initial starting prices although I am not so sure that distributions are considered at chart sites.

Now Proshares never categorically stated that you would make/lose 2x...They simply stated that was the goal. But being the cynical person that I am I did not believe it and as the months wore on it became obvious that I was right.

Back in ’06 I asked a broker how Proshares could hope to reach this goal. He said ”Maybe they buy/sell twice as much”...Now you know why I would never use a full service broker.

I never took the time to try and figure out what Proshares is doing...Something about Swaps, Options, Futures and other exotic measures...But does it really matter?

Some believe that the Ultra ETFs moves are based on their Net Asset Value (NAV) similar to Mutual Funds. However, I believe that the Ultras move based on Supply/Demand. The present value of anything is based on what the highest bidder will pay you right here right now for it. Determining future value is more complex and is beyond what I am writing here today.

So, do the Ultra ETFs come anywhere close to meeting their 2x (or even 3x) goal? I believe that after you look at the graphs below you will come to the same conclusion that I have...NO WAY!

Recently I have seen a number of articles debunking the 2x and 3x myth. Even Proshares has come out and said that the goal is usually only reached on a daily basis rather than long term...Duh!!! However, I have seen days when both Ultra Longs and their Ultra Short counterparts were both green or red on the same day. Take a look at QID/QLD on 3/19/09...TZA/TNA on 3/11/09...DIG/DUG on 2/12/09.

Before we look at real life graphs let’s look at this mathematically:

QID and QLD attempt 2x the movement of the $NDX. Lets assume that the $NDX moves 20% in each direction during 6 periods and that the Ultras move 2x that amount during each period.

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The above demonstrates that if you were to hold QLD or QID over the entire 6 periods you’d be a big loser. One would think that the investor holding QID would have been a winner since the underlying index was down over 11% over the entire 6 periods.

So who wins here? Certainly not the long term Ultra Investor. But let’s suppose you are a Savvy Trader who can accurately call each up/down period of the underlying index. The trader would fip/flop as the $NDX turned. If the trader was 100% right they would make 40% during each of the 6 periods and would be up over 650% over the 6 periods.

Of course nobody can call every turn and since the Ultras do not move 2x (or 3x) everyday or every period a 650% gain is pretty much a fairy tale. But the savvy trader could do very well trading the turns.

So now we see that Ultra ETFs belong in the Trader’s Toolbox...But I think after you look at the graphs below you’ll agree that they do not belong in the Investor’s Toolbox.

Lets go to the Real World now and look at some graphs. Since I believe that most chart sites do not account for distributions we will not go back before the end of last year.

QID/QLD YTD...Everybody loses:

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UYG/SKF...Everybody loses:

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FXI/FXP...Everybody loses

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DIG/DUG...Everybody loses

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TZA/TNA...Everybody loses

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Yes...You can find different time frames where these Ultras worked and even exceeded their goals...But it isn’t as easy as the Net Gurus said it was gonna be.

Comments are welcome...Best, Doug

PS: This report was inspired by an article I read in IBD last week...Believe it or not...LOL

http://sharptraders.com/_wsn/page5.html