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ETF Leverage reversal

#1

What do you guys think of ETF Leverage reversal system. It had 3 years of good results: around 30%/yr return and max drawdown around 25%.

Then suddenly it made all these huge losing trades.

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#2

He had a good run in a steady bull market but now it is over.
Basically the majority of systems.

#3

At its core was an arbitrage system that worked well. It doesn’t work well in volatility (I think) … so such systems should shut down when volatility spikes. He continued on for a week longer than he should have … and then kept adding on long positions that only lost more … Good core system, but managed poorly it seems.

2 Likes
#4

Good points. The long stock positions have no relation to the core arbitrage strategy that the system is supposed to use. One of the attractions of the system is that an arbitrage strategy is uncorrelated to the market but that is ruined by these regular (unhedged ) stock trades.

I don’t think this arbitrage system can’t work in a high volatility environment. It’s just that the system needs to take smaller positions when the volatility is higher. That’s because with the bigger movements you can use smaller positions and still have the same profit as before. With big positions and high vol it is difficult to keep the trade open when it goes against you. The arbitrage strategy makes use of the fact that leveraged ETFs decline over time so you might need to hold the positions for some length of time when the trade temporarily goes against you. This system made a huge loss on the arbitrage ( hedged ) trade and instead of continuing with smaller position sizes, closed that and then started taking long positions in regular stocks. If he had continued with the paired hedge trade then that trade actually went in the system’s favor a few hours after he closed it!

There are plenty of systems going long on pullbacks. The arbitrage part of this system made it interesting. I’m not sure a system buying regular stocks on pullbacks and without a stop loss / risk management is very useful.

This shows that trade management and risk management are maybe more important than the ideas behind a system.

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#5

This is an interesting strategy. I’ve never traded arbitrage before but I always assumed these types of strategies would outperform during times of volatility because the discrepancies between the two pairs would be wider than normal.

#6

This type of strategy works when the moves in the shorted paired etfs are up and down ( one day up, one day down). Then both the ETFs lose value from volatility drag. When you get many consecutive days of one of the ETFs going up, the system loses money. This system does the paired trade usually with 3x Gold Miner ETFs. There was a period last week where the Gold prices kept falling for many days. That’s when the huge loss happened.

Really this type of system should divide it’s risk over multiple pairs of uncorrelated ETFs.

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#7

That makes sense for leveraged ETFs. I was thinking more of traditional arbitrage strategies that trade the same asset in different markets. Thanks!

#8

Yes. Ideally you want pairs that are uncorrelated (not just negatively correlated)… Unfortunately in these high volatility times we do end up with assets that tended to be less correlated becoming more correlated. And then we get the Saudis and the Russians having a pissing match to try and break the US shale producers at just the wrong time…

Sad to see this system blow up. I was a subscriber but bailed quite a while ago because there were directional trades in there and when I queried these they were being used to juice the returns… I have plenty of market-beta elsewhere in my portfolio. The last few weeks haven’t been too bad for this strategy in that we’ve had good day-by-day reversion. But, there have been some tough draw downs there as well as there’ve also been some big multi-day moves.

I closed out my DUST/NUGT pair yesterday as it looked as though Direxion had some issues in setting up the daily derivatives after that massive one day move the day before. I closed my OILD/OILU earlier than I probably should of as a risk management move. Gave up a good chunk of upside (well recovering some downside on that pair). YANG/YINN performed well; in fact any of the pairs based on equity underlying’s would have done quite well lately. I am flat at the moment and will probably move back in by scaling in over a few days.

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#9

This is a good article from Bloomberg on why we’ll likely see quite a disconnect between the Miners (NUGT/JNUG etc…) and Spot and Forward gold prices over the next wee while.
https://www.bloomberg.com/news/articles/2020-03-26/the-gold-market-is-facing-unprecedented-turmoil

Important to remember than those leveraged ‘Gold ETFs’ are actually leveraged Gold Miner ETFs…

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