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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Inital drawdown
More on brokers calling in shorts
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.