How to Avoid Drawbacks of ETF Trading

The Technology Bull 3X ETF TECL seeks daily investment results, before fees and expenses, of 300%, compared to the price performance of the Russell 1000 Technology Index.  On the other hand, TECS is Technology Bear 3X ETF, when Russell 1000 Technology Index goes up every 1%, TECS is expected to drop 3%, and vice versa.
 

 

 

TECL vs. TECS from 6/1/2012 to 4/19/2013.

Source: Line Graph Outline form Yahoo Finance.  Actual data compiled by Authors.

If you draw a chart to compare TECL with TECS on Yahoo Financial site, you will notice that chart looks like a wedge shape. Theoretically, the sum of the values of TECL and TECS should be 0 all the time. 

As a matter of fact, during the time period between 6/1/2012 and 4/19/2013, the return rates for TECL and TECS were 18% and -32%, respectively. You lost 14% in total.  However, if you shorted both of them, conversely, you made a 14% total capital gain. Remember, you have to take into account the margin interest you pay to short securities. 

ETFs may decay in value over time. Generally speaking, the low beta ETFs will decay overtime slower than the high beta ETFs.  If you want to hold the ETFs over a medium to long term, 1X ETFs might be a better choice. 

          

Often times, the average investor will be too tempted to speculate with ETFs, instead of taking the more buy-and-hold approach.

Furthermore, ETFs don’t always closely track their benchmarks.  On a volatile trading day, like the “flash crash” on 5/5/2010, when the stock market briefly fell 1,000 points, the big financial institutions, that normally guarantee smooth trading of ETFs, couldn’t handle the wild price swings. Many ETFs fell far more than the value of their underlying investments. In a situation like this, the panic will exaggerate the selling force, and the sell-off may be catastrophic.

Recent studies show that the leveraged ETFs could be a main cause for the next flash crash-like disaster in the financial market.  You can find more details about this research by following this link:

http://blogs.barrons.com/focusonfunds/2013/08/12/yes-leveraged-etfs-could-be-destabilizers-fed-study/?mod=yahoobarrons

If you want to find out more information about this topic, you can visit:

http://www.barnesandnoble.com/w/top-5-technical-indicators-for-etf-trading-jing-zhang/1116853458?ean=2940148725206

Thanks for your reading. Come back more often, more updates are coming.