Small Investors Should Beware of These Increasingly Popular ETFs

Now you can buy leveraged ETFs for single stocks, including Nvidia, PayPal, Nike and Pfizer. They are risky.

You’re probably familiar with leveraged exchange-traded funds, which can offer two or three times the daily gain or loss of indexes like the S&P 500.

Now you can buy leveraged ETFs for individual stocks, including Nvidia  (NVDA) – Get NVIDIA Corporation Report, PayPal  (PYPL) – Get PayPal Holdings Inc. Report, Nike  (NKE) – Get Nike Inc. Report and Pfizer  (PFE) – Get Pfizer Inc. Report. These are known as single-stock ETFs

But leveraged ETFs of any kind don’t make sense for most investors. That’s because they aren’t meant to be used for more than a day, since they are rebalanced daily.

Here’s an example of what can go wrong if you hold leveraged ETFs for more than a day:

Say you buy the AXS 2X Nike Bull Daily ETF NKEL at $36 with Nike itself trading at $100. 

And say the stock goes up 5% the first day to $105. Doubling that 5% to 10% adds $3.60 a share to your ETF position, leaving it at $39.60.

Then assume the stock goes back to $100. That would be a 4.8% decline, which means a 9.6% loss for your position. 

The loss would total $3.80 a share, leaving the value of your position at $35.80.

Return Discrepancy

So while Nike’s stock price was unchanged for the two-day period. Your ETF dipped 0.6% from its original $36 level. If you held 300 shares of the ETF, that’s a loss of $60. 

While this by itself isn’t a huge sum, the discrepancies in returns can grow quickly if you continue to hold the ETF.

If you’re a day trader, leveraged ETFs, including single-stock ETFs, can make sense. You can use them to speculate or to hedge. The speculative case would be guessing whether Nike will rise or fall on a certain day.

A hedging possibility would be buying an ETF of consumer discretionary stocks in expectation of a rise, and then buying the AXS 2X NKE Bear Daily ETF NKEQ as a hedge. This ETF rises when Nike shares fall.

The hope would be that if the consumer discretionary ETF fell, you’d make up for the loss with gains from the Nike ETF.

Day-Trading Danger

But before you get too excited about the possibilities, remember that most day traders fail to make money. You generally have to be an extremely educated and talented trader to succeed.

Most experts agree that the best approach to ETFs is to buy broadly diversified funds with low expenses and hold them as long-term core investments.

If you want to buy individual stocks, there’s nothing wrong with that. But you don’t need a single-stock ETF to do it.

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