Investor Education Course 04: The Implementation Principles of Leveraged ETFs and Applicable Groups

What is a Leveraged ETF

After entering the US stock market, you will find many trading varieties of nested derivatives, such as the frequently seen X times long XXX, where the first X refers to the leverage multiple, commonly 2 times or 3 times, and the following XXX is the name of the underlying asset. This investment variety is called a leveraged ETF.

A leveraged ETF is an ETF that incorporates financial derivatives to amplify both gains and losses. Compared to directly purchasing through margin financing, leveraged ETFs have the advantages of not requiring a margin account and lower costs than financing rates. A commonly seen leveraged ETF fund is the 3x long Nasdaq 100 Index fund, code: TQQQ.

First, let's talk about what TQQQ is. Simply put, it is the "super amplified version" of the Nasdaq 100 Index. If QQQ rises by 1%, it rises by 3%; if QQQ falls by 1%, it falls by 3%.

Speaking of the principle, many people are curious about how TQQQ achieves the threefold amplification. For example, if you have $10,000 and want to achieve $30,000 in gains (or losses), the fund manager of TQQQ will use financial tools like futures and swaps to help you achieve this "small investment for large returns" goal.

Characteristics of Leveraged ETFs

There is a particularly interesting detail here: TQQQ adjusts its positions daily to ensure it maintains 3x leverage at the market open the next day, much like a magnifying glass that needs to be recalibrated every day to ensure the amplification remains at 3 times.

Let's take a practical example. Suppose you invested $10,000:

On the first day, if QQQ falls by 10%, your TQQQ will fall by 30%, leaving you with $7,000.

On the second day, if QQQ rises by 11%, your TQQQ will rise by 33%, becoming $9,310.

In the end, you find that QQQ essentially hasn't lost money (a 10% drop followed by an 11% rise is roughly back to the original position), yet you inexplicably lost $690.

This is the "pitfall" of TQQQ. On the surface, it appears to be 3x leverage, but after holding it long-term, you will find that the returns are not simply a 3x relationship. Especially in a volatile market, money seems to be put into a shredder, disappearing little by little. Therefore, this type of ETF is not suitable for long-term holding, as these erosions will consume most of our profits, particularly in a fluctuating market (which is the nature of financial markets).

Last year, when tech stocks plummeted, TQQQ's maximum decline exceeded 80%. What does this mean? $1 million turned into $200,000! This is not to scare you; it is a reality that has happened. So I always say that playing with TQQQ is like dancing on the edge of a knife; it is thrilling, but a moment's inattention can lead to bloodshed.

Who is Suitable for Leveraged ETFs

So, who is TQQQ suitable for? My suggestions are:

Those who really understand this product well

Money that can be afforded to lose (important things are worth repeating three times!)

Short-term trading; do not use it to save for retirement

At most, use 15% of total assets to play; more than that is just seeking thrills

If you find TQQQ too stimulating, you can consider:

Honestly buying QQQOr choose the milder 2x leveraged QLD.

If that doesn't work, then ETF dollar-cost averaging, a steady happiness.

Source: wallstreet Xiaobai