Here is an example of a hypothetical index that starts at 1000
and goes up or down every day by 50 points. (1 day up, the next
down, the next up etc.)
And the decay effect shown if you short both 3X direct and
inverse in the amount of $10K each. As you can see, this is quite a
decay rate.
The problem is compunding is a two edged sort. If the market
trends for an extended period, it hurts considerably. As the second
table shows, if the same index goes up by 50 points a day for 20
days, then you are out of pocket by over 275% of your original
shorts, while the underlying index has only doubled.
3X ETF's work by moving 3X the move in the underlying index from
the previous day's close. When market trends for a few days in a
row, this is a compunding effect on the upside and inverse
compounding effect on the downside. If you enter the shorts at the
beginning of a trend, one of the ETF's will go up on a daily
compunded basis, while the other will go down in incrementally
smaller and smaller dollar value. This will cause an imbalance and
a drawdown. Once trend is reversed, and market is choppy, the decay
effect will erase any drawdown.
If you are lucky enough to time it so you enter the shorts at
the beginning of a non-trending market, then all you get is the
decay and will not have the inital drawdown.
BTW, in a strongly trending market, this drawdown can come into
play at any time, but its effect tends to be maximized in the
beginning because you have the most money in play.
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Initial drawdown
More on brokers calling in shorts
Posted by junkmaylbox on 17th of Jul 2009 at 04:47 pm
Could you please explain why or where it comes from?
Decay effect
Posted by mamaduck on 17th of Jul 2009 at 05:30 pm
Here is an example of a hypothetical index that starts at 1000 and goes up or down every day by 50 points. (1 day up, the next down, the next up etc.)
And the decay effect shown if you short both 3X direct and inverse in the amount of $10K each. As you can see, this is quite a decay rate.
The problem is compunding is a two edged sort. If the market trends for an extended period, it hurts considerably. As the second table shows, if the same index goes up by 50 points a day for 20 days, then you are out of pocket by over 275% of your original shorts, while the underlying index has only doubled.
Inital drawdown
Posted by mamaduck on 17th of Jul 2009 at 05:04 pm
3X ETF's work by moving 3X the move in the underlying index from the previous day's close. When market trends for a few days in a row, this is a compunding effect on the upside and inverse compounding effect on the downside. If you enter the shorts at the beginning of a trend, one of the ETF's will go up on a daily compunded basis, while the other will go down in incrementally smaller and smaller dollar value. This will cause an imbalance and a drawdown. Once trend is reversed, and market is choppy, the decay effect will erase any drawdown.
If you are lucky enough to time it so you enter the shorts at the beginning of a non-trending market, then all you get is the decay and will not have the inital drawdown.
BTW, in a strongly trending market, this drawdown can come into play at any time, but its effect tends to be maximized in the beginning because you have the most money in play.