How to Day Trade Using Leveraged ETFs

Leveraged ETFs are exchange-traded funds that use a combination of derivatives and debt instruments to double or triple the movement of an underlying asset or index that it tracks. Owing to their leveraged nature, these funds are incredibly volatile and risky. Leveraged ETFs have grown in popularity with the day trading crowd because the funds can generate returns very quickly (provided, of course, the trader is on the right side of the trade). In this article, we will look at some of the most popular leveraged ETFs on the market and discuss strategies for minimizing losses when using these ETFs. Be aware that while all trading carries risks, leveraged trades are far riskier. These funds should only be tackled by an experienced trader with a stomach to handle losses. (See also: Dissecting Leveraged ETF Returns.)

First and foremost, before trading these volatile instruments, you must be aware of what they track. With two-to-three times the potential of upside and downside moves, even a slight miscalculation on their underlying properties can wreak havoc on an otherwise winning trade. Below are some of the most popular leveraged ETFs on the market and the asset or assets that they track.   

Even if you are planning on closing your positions at the end of the trading day, it would be wise to get a brief understanding of the fundamental factors that can impact these ETFs. Although technical analysis will probably be the main tool in your arsenal, fundamental factors from around the world, especially events that happen overnight, can dictate the direction of the trend the following morning. Below, we'll discuss the fundamental factors that can affect some of the most popular leveraged ETFs.

The Direxion Daily Gold Miners Index Bull 3x Shares (NUGT) and the Direxion Daily Gold Miners Index Bear 3x Shares (DUST) track the New York Stock Exchange (NYSE) Arca gold miner’s index, which is affected by geopolitical events, natural disasters, fluctuations in the U.S. dollar and announcements regarding U.S. monetary policy. Key information releases to watch for when trading these two are the Federal Open Market Committee meeting (FOMC) statements, which are released about three weeks after each of the committee’s eight yearly meetings, and monthly economic reports that can potentially impact monetary policy, such as the Consumer Price Index (CPI), the Employee Situation Report and retail sales reports. (See also: Economic Indicators to Know.)

The ProShares Ultra Bloomberg Crude Oil (UCO) and the ProShares UltraShort Bloomberg Crude Oil (SCO) track the Bloomberg WTI Crude Oil Subindex. As such, they are affected by moves in oil prices due to geopolitical events and North American supply and demand. Key information releases to track are the American Petroleum Institute's “Weekly Statistical Bulletin,” on Tuesdays, and the Energy Information Administration's report, “This Week in Petroleum,” on Wednesdays, on U.S. inventories.  Another important information release is the Baker Hughes rig count, published every Friday at noon central time. (See also: Understanding Benchmark Oils: Brent Blend, WTI and Dubai and Uncovering Oil and Gas Futures.)

The Direxion Daily Small Cap Bull 3x Shares (TNA), Direxion Daily Small Cap Bear 3x Shares (TZA), ProShares UltraPro S&P 500 (UPRO), ProShares UltraPro Short S&P 500 (SPXU),  ProShares UltraPro (TQQQ) and the UltraPro Short QQQ (SQQQ), are all trackers of major U.S. benchmark indices. As such, they are susceptible to the many macroeconomic factors that affect the U.S. capital markets. These can include the following:

• Geopolitical events 
• Volatility in international equity markets
• Economic reports and Federal Reserve announcements
• Earnings reports by major companies
• Volatility in the bond markets and futures markets

The Direxion Daily S&P Biotech Bull (LABU) and the Direxion Daily S&P Biotech Bear 3x (LABD) track the NYSE Arca Biotech Index and are susceptible to the same ebbs and flows of the American capital markets. However, as they are concentrated in the biotech sector, keep an eye out for results from U.S. Food and Drug Administration clinical trials, mergers and acquisitions of biotech firms, and earnings reports from the big-name biotech companies. These include, Gilead Sciences (GILD), Celgene Corp. (CELG), Amgen Inc. (AMGN), Regeneron Pharmaceuticals Inc. (REGN) and Biogen Inc. (BIIB).

Direxion Daily Emerging Markets Bull 3x (EDC) and the Direxion Daily Emerging Markets Bear 3x (EDZ) seek to replicate three times the movement of the MSCI Emerging Markets Index. Although a guide on trading the MSCI Benchmark could fill a book, keep an eye out for overnight swings in commodities, the Asian and European markets, forex markets and economic news coming out of the index's constituents, as these factors can heavily dictate the direction of the next trading day. (See also: How a Strong U.S. Dollar Can Hurt Emerging Markets.)

Unlike most guides on trading, this one will feature no strategies on technical analysis owing to its subjective and after-the-fact nature. I will assume that the reader has already built a familiarity with the basic principles of technical analysis and can adapt those techniques to trading leveraged ETFs. Here are a few additional tips:

1. Set Stop Losses. Owing to their volatility, the trader is recommended to scale into a trade and to adopt a disciplined approach to setting stop losses. Furthermore, as big swings are quite common in these securities, set stop losses wide enough so that you do not get stopped out before a massive run in the direction of your hypothesis.
2. Do Not Hold Shares Overnight: Don't hold positions overnight, as global events can obliterate your trade. It is not uncommon to see leveraged funds gap down 5% to 10% the next morning. Your stop losses will not protect you in such instances. Either reduce positions or close them out entirely at the end of the day.
3. Follow Paul Tudor Jones. Famous hedge fund manager and trader extraordinaire, Paul Tudor Jones, had this piece of advice stuck to his office wall: “LOSERS AVERAGE LOSERS.” While averaging down is an excellent strategy for long-term investors and swing traders, averaging down on a losing trade in a 3x ETF is like throwing your money out the window.

Leveraged ETFs are not for the faint of heart. Traders who can stomach the volatility can realize large gains (or losses) on their positions very quickly. That said, when trading these wild instruments, be sure to check the underlying asset that they track so you can have a sense of direction they will take each trading day. Furthermore, traders who bet on these funds should have an adequate risk management strategy in place and be ready to close out their positions at the end of each market day.