foxex: Catching Up

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Chart Advisor | Focus on the Price

By Gordon Scott, CMT

Wednesday, May 20, 2020

1. Stocks hold on to gains through Fed minutes

2. Leverage is better for trading short term

3. Who is buying Nasdaq companies?

Market Moves

This afternoon the Federal Reserve released the detailed minutes of its most recent meeting on rates. Though this information can sometimes rattle market indexes, the effects were short lived as markets regained their highs for the close. The S&P 500 index (SPX) closed 1.7 percent higher while the Nasdaq 100 (NDX) closed a full three percent higher on the day, leaving yet more evidence that investors are not shying away from this market.

In the current circumstances, some investors may be tempted to repair losses in their portfolio by trying to use leveraged instruments to play catch up. Certain ETFs are designed to help investors do just that, however, it is important to understand the risks of using such tools. The chart below compares State Street's S&P 500 index ETF (SPY) with two leveraged ETFs for the same index offered by Direxion. The first is leveraged long (SPXL) and the second is leveraged short (SPXS). The chart also compares an average price of the two ETFs and displays all four on a logarithmic scale (so that the same percentage move appears visually consistent on the chart).

The key point to notice here is that the average price (black line) is significantly lower than its former peak, compared to SPY (blue line) which does not have as far to go to get back to its high for the year. This is also true for SPXL (green line). The reason for these discrepancies has to do with the daily recalculation done by the fund managers of these ETFs. The recalculation works on a day-by-day basis, but when big moves occur (such as those in the past month). It skews the results and leaves investors with a longer path to the top.

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Leverage is Better for Trading Short Term

The chart below shows more evidence of the problems associated with holding on to leveraged instruments. Consider that the S&P 500 (as tracked by SPY) is back to its level of one year ago. Shouldn't that mean that a triple-leverage fund that follows the same index should also be back to break even? Alas it is not the case. Shares of SPXL are still more than 25 percent lower than they were one year ago.

However, if you thought you'd have done better by going short for that duration, you'd be wrong again. Those holding SPXS for the past year have given up more than half of what they started with. The average loss for holding these instruments for a year is over 35 percent.

Traders using these funds did very well if they favored SPXS in March and SPXL in April. Thus it is apparent these require some skill to use properly. The verdict? Don't hang on to these instruments for more than a couple months, and you'd better have a good timing mechanism for getting in and getting out.

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Who is Buying Nasdaq Companies?

If you haven't read the report on Investopedia's latest survey of active investors, consider doing so. It is worth the time spent. The short answer to the question above is that younger investors are both propping up the market, and choosing to do so with big name technology companies. That they should choose to do so is not terribly surprising. That the efforts of so many young people are working so well is the important fact.

Consider the chart below which shows ETFs from the major indexes. The Nasdaq shows upward-trending support, while the Dow Jones Industrial Average shows resistance. That alone speaks volumes.

The Bottom Line

Stocks lifted strongly this morning and didn't give back gains after the Fed minutes were released. Some investors may be tempted to try to catch up using a leveraged investment vehicle, but they need to study the performance of the tools carefully so they know what they are doing. Meanwhile, the Nasdaq 100 is leaving other broad market indexes behind.