Swing Trading Strategies & Stock Picks Since 2003

You might ask “How can that be possible?”  The XLF Financial ETF is down roughly 30% year to date, but the SKF (as of March 24), which is the double inverse (short) leveraged Financial ETF… which you would think would also be up 60%… is also negative:  down 3%.

Let’s see the performance year-to-date up to Tuesday, March 24, 2009:

The SKF actually was negative 10% on March 23 year-to-date while the XLF was down 24%.

Today’s market fall is likely to take the SKF positive for the year, but even that is begging the assumption most newer traders have that the SKF returns two-times (inverse) the XLF performance.

I’m on a campaign here to inform newer traders (and even experienced traders with little experience in inverse funds) to look very closely at double (and inverse) funds - particularly to avoid using them as long-term hedges and/or position trading vehicles.  Use them as short-term “supercharges” to day and week-long (at the most) swing trades.

Again, among other reasons (the way the fund is structured, etc), double funds suffer from the ‘drawdown’ phenomena, where, to get back to break-even after a loss, it takes a larger percentage to return to where you were.

Forget the leveraged component for a moment.

If you have a $100,000 account and manage to lose 50% of that account, then you’re down to $50,000.

Now, to get your account back to ‘break-even’ at $100,000, you can’t expect a 50% return to do it for you.  50% of $50,000 is $25,000.  If you lose 50%, you actually need a 100% return ($50,000 of $50,000) to get you back to where you started.

This is the problem facing leveraged funds tied to underlying indexes or sectors.  Percentage-wise, the funds track moves short-term, but dollar-wise, they don’t because of this “drawdown/percentage” function.

Look very carefully at the implications of this, and stick to using leveraged funds as day-trading or short-term swing trading vehicles only.  Refer back to my post yesterday “You Can’t Stay Wrong for Long in SKF” for additional information.

Corey Rosenbloom
Afraid to Trade.com