Why do inverse ETFs rebalance daily?
Here's why leveraged and inverse ETFs reset daily: Daily Rebalancing: Leveraged and inverse ETFs use financial derivatives that provide returns based on the daily performance of the underlying index. To maintain their desired leverage or inverse exposure, these ETFs must rebalance their positions daily.
Leveraged and inverse funds that have daily resets are attempting to achieve their objectives on a daily basis, not over a week, month or longer period; as a result, clients should not assume or expect the performance of a leveraged or inverse fund over a period of time in excess of one trading day to track or even ...
Compounding Risk
Since an inverse ETF has a single-day investment objective of providing investment results that are one times the inverse of its underlying index, the fund's performance likely differs from its investment objective for periods greater than one day.
Inverse ETFs have a one-day holding period. If an investor wants to hold the inverse ETF for longer than one day, the inverse ETF must undergo an almost daily operation called rebalancing. Inverse ETFs can be used to hedge a portfolio against market declines.
The two most common strategies for rebalancing are: Periodic rebalancing: You rebalance at fixed intervals, for instance every 6 months, or every year... Threshold-based rebalancing: You rebalance when one of the ETFs in your portfolio goes out of balance by a certain percentage, for instance 5%.
An inverse ETF is a fund constructed by using various derivatives to profit from a decline in the value of an underlying benchmark. Inverse ETFs allow investors to make money when the market or the underlying index declines, but without having to sell anything short.
Most leveraged and inverse ETFs reset each day, which means they are designed to achieve their stated objective on a daily basis. With the effects of compounding, over longer timeframes the results can differ significantly from their objective.
Inverse ETFs aren't intended for long-term bearish movements or for hedging your portfolio against longer-term downswings because of the disadvantage of daily rebalancing.
Yes, an inverse ETF can reach zero, particularly over long periods. Market volatility, compounding effects, and fund management concerns can exacerbate losses. To successfully manage possible risks, investors should be aware of the short-term nature of these securities and carefully monitor their holdings.
This shows that the potential for both profit and loss can be magnified with leveraged inverse ETFs. It is also important to note that leverage also means it is possible that a leveraged inverse ETF can go to zero or near zero with a large enough daily move in the price of the underlying asset or index.
Why should you not hold SQQQ overnight?
For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant. Smaller index gains/losses and higher index volatility contribute to returns worse than the Daily Target.
ProShares UltraPro Short QQQ (SQQQ)
If the Nasdaq-100 falls 1% over a day, then the fund is expected to return 3%. Since SQQQ's leverage resets on a daily basis, holding the fund beyond a single day may compound returns and provide results that are different from the target return.
If you buy an inverse ETF and the market associated with your fund rises, you will lose money. If the fund is leveraged, you could experience dramatic losses. Market downturns and bear markets are entirely different than rising markets.
The Fund seeks investment results for a single day only as calculated from NAV to NAV, not for any other period. The Fund seeks to engage in daily rebalancing to position its portfolio so that its exposure to the Index is consistent with the Fund's daily investment objective.
The bottom line. Our research shows that optimal rebalancing methods are neither too frequent, such as monthly or quarterly calendar-based methods, nor too infrequent, such as rebalancing only every two years. For many investors, implementing an annual rebalancing is optimal.
The disadvantages are complexity and trading costs. With so many ETFs in the portfolio, it's important to be able to keep track of what you own at all times. You could easily lose sight of your total allocation to stocks if you hold 13 different stock ETFs instead of one or even five.
| Ticker | ETF Name | 1 month return |
|---|---|---|
| KOLD | ProShares UltraShort Bloomberg Natural Gas | 11.99% |
| BZQ | ProShares UltraShort MSCI Brazil Capped | 7.73% |
| AAPD | Direxion Daily AAPL Bear 1X Shares ETF | 6.60% |
| TMV | Direxion Daily 20+ Year Treasury Bear 3x Shares | 4.39% |
Say an investor buys a 3X leveraged ETF and the underlying index drops by 1%, our investor just incurred a 3% loss. This same concept applies when investing in inverse leveraged ETFs, but with an opposite effect. If the index gains 1% and the investor holds a 3X leveraged inverse ETF, the investor would lose 3%.
The single biggest risk in ETFs is market risk.
As the name suggests, day trading is a short-term investment strategy. The goal is to exit all your trades by the end of the day, holding no securities overnight. Contrast this approach to long-term investing, where you buy and hold the same position for months—or even years.
What does daily leveraged mean?
Daily leveraged exposure means the compounding effect will be amplified and occur daily, which can have a positive or negative effect on returns over longer periods.
Direxion Single Stock Daily Leveraged & Inverse ETFs allow sophisticated traders to get magnified or inverse exposure to popular individual securities, in order to seek profit or hedge risk regardless of market direction.
Holding an inverse ETF for more than a day can produce returns that don't track with the total return of the underlying security. The more volatile the underlying security, the greater the tracking error.
