On the issue of 3x vs 2x leveraged ETFs

I think there has been some confusion here at Bull Markets recently.

  1. I think the long term risk:reward favors bears. That doesn’t mean I’m long term bearish yet. Market outlook and risk:reward are not the same things.
  2. I think there’s a 70% chance the stock market goes on to make new all-time highs, or at least comes close to making all-time highs in 2019.
  3. December is going to be volatile (this isn’t something that you need me to tell you – just look at the charts).

But there’s something else I’d like to mention.
Since starting this website, I have advocated using $SSO and $UPRO to trade. It’s clear to me that some members don’t have the stomache to trade $SSO and $UPRO.

From 2008 – 2017

As some of you know, I worked in my family’s fund from 2008 – 2017. During that period, we 40x’ed our capital, which amounts to an average annual return of 44.6%
Our fund exclusively traded USLV (silver’s 3x leveraged ETF) and NUGT (gold miners leveraged ETF), with smaller positions in UPRO.
But how did we achieve such high returns? High returns comes with high risk and high volatility. You simply cannot have one without the other. (This explains why most traders can’t beat buy and hold. They want stock-market like returns with bond-market like volatility.)
Let me give you a sense of our portfolio’s volatility from 2008 – 2017

  1. There were 3 times when we were down -50% from our high watermark, and countless times when we were down -30% (NUGT is crazy). Our strategy for NUGT was to buy into crashes. When it comes to “catching the falling knife”, you can almost always expect big losses in the short term (because no one can catch the exact bottom), followed by massive gains in the medium-long term.
  2. There was 1 time when we made 500% in 9 months.

Hence, a lot of our conversations would go like this in the afternoon “how much are we down this morning? -30%? That’s normal.”
Most traders are scared of volatility. We weren’t, because we generally knew what we were doing and which drawdowns were within normal parameters. Moreover, a big loss didn’t have a material impact on our finances. Past a certain point, money can only buy you so much unless you intend on purchasing private jets and islands. Since our drawdowns didn’t have a material impact on our financial wellbeing, we were able to remain unemotional and calm during drawdowns, which ultimately helped us massively outperform in the long run.

Why am I telling you this?

I started Bull Markets with the intention of helping people achieve the returns that we had. Not 10%. Not 20%. 30%+ (my parents used to say if you’re not making at least 20% a year, you’re wasting your time. Those were the high expectations we set).
Achieving 40%+ returns can only be done through greater than normal leverage, which also means the occasional large drawdown.
However, I now see that most readers cannot stomache this kind of volatility. When creating this website, I thought that everyone could have the same kind of risk tolerance and pain tolerance that we had. Clearly I was wrong.
It’s a sound strategy in the long run, but most people simply cannot stomache it. Everyone is entitled to their own risk-tolerance.
Hence, going forward, I recommend that people trade $SPY and $SSO instead of $SSO and $UPRO. Your returns will decrease, but you need to use the kind of leverage that you are emotionally and psychologically comfortable with.
So if you’re going to use $UPRO, please see the Medium-Long Term Model’s max drawdowns and understand what’s within the normal parameters.

16 comments add yours

  1. That means your recco with short term model if we are aggresive is use upro instead of sso?

    • Yes, if you are really aggressive. But seeing how most people can’t tolerate those sort of drawdowns, it’s better to stick with $SSO, unless you know that you can stomache the drawdowns

  2. I’ve traded SSO and UPRO, but only when I had backtested and felt really confident in my strategy. Most people I talk to would never trade leveraged ETFs, but then their only strategy is buy, hold and hope. If you have a solid strategy (based on testing/data, and not just opinion), I think it’s so worth it to get 2-3x over simply 1x. I am really delighted that you are sharing your research/models here because my own strategies are limited – thank you!
    No doubt everyone has to trade at a level they are comfortable with, and I believe ultimately find their own trading style.
    P.S. I think there might be a typo in #1 at the top of this post… favors bears.

  3. You are right, most investors cannot tolerate big drawdowns or to put it differently you could give someone a fabulous money making system and they probably couldn’t follow it and make money because of human emotions. But knowing the expected maximum drawdowns helps a lot.

  4. Hi Troy
    Is the fund open for outside investors? And is there a website for your family business/investment company?
    Kind regards

    • Hi Magnus,
      No it is not, except to some family and friends. As you would imagine, most investors do not have the pain tolerance for 50% drawdowns

  5. The mental component is definitely one of the hardest parts to learn related to trading. Being able to calmly handle fluctuations between euphoria where everything is going your way and you feel like a genius. And the days where you feel that you’d like to throw up and every bit of your body is telling you to sell-sell-sell and you’re convinced you are the biggest idiot in the world.
    I don’t think most people have the risk appetite to handle even medium size drawdowns, not to even consider large ones. You can teach people technical, macro, risk and trade management, but you can’t teach them mental game. I think to be a good trader, you need to have experienced losing or almost losing it all after significant success. And still decided that you wanted to be in the game, because you love it.

  6. Thanks Troy, that DD chart is very useful – and also not unexpected. My way of handling that kind of probability is to use the model as 1 strategy in a portfolio of 4-5 strategies, all having different profiles. One of my existing ones has a MaxDD of -55%, so UPRO is ok using this model. Having said that, there might be times when I would scale down to SSO.

  7. I agree, most people should use non-leveraged only vehicles to trade/invest. But there are those of us that want to use leveraged etf’s and options, and that’s ok, we can easily translate returns expectations based off of SPY to the vehicle that we prefer to “juice” returns, or losses when it goes against us.

  8. How did you trade silver/gold and achieve those returns? That would make for a good blog post..

    • Instead of writing a blog post, I might create a video. Much easier to demonstrate it on a chart

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