Trading Leveraged ETFs? It’s All About the Stops
Trading leveraged ETFs comes with a significant amount of risk, especially if the market begins moving against you.
This is why advisers recommend using a stop loss order. Often referred to simply as a stop, it directs your brokerage to automatically sell a stock or ETF if it falls to a pre-determined level. This is intended to limit an investor’s loss on an investment.
There are essentially two kinds of stops:
- A hard stop that causes the stock to be sold if it hits a particular price.
- A trailing stop that causes a stock to be sold if it falls a particular percentage from the most recent high
With leveraged ETFs it can sometimes be tricky setting stops. An investor must evaluate the underlying index and translate that evaluation into an appropriate stop for the leveraged ETF. This is necessary because the price action of the ETF is totally dependent on the performance of the underlying index.
Some ETFs are leveraged 2X, such as the ProShares ETFs. Others are leveraged 3X like the Direxion ETFs. Moves in the underlying index will tend to be exaggerated in the leveraged ETF so it is very important to understand how the leveraged ETFs will react.