It’s a Sunday night and Jill believes the markets will swing upwards tomorrow. On Monday morning she buys $100 dollars of a daily 3x leveraged bull ETF for a total of $300 dollars of market exposure.<\/p>\n
Unfortunately for Jill, her prediction is wrong, and her ETFs benchmark index declines 5% from 100 to 95 points. Her daily 3x leveraged bull ETF returns 300% of that loss for a total of a 15 percent decline. Her ETF is now worth just $85 which means that Jill will start Tuesday with just $255 dollars of exposure to the market. At this point a prudent investor might decide to cut their losses and exit their position. But for explanatory purposes we’ll continue.<\/p>\n
On Tuesday the index declines from 95 to 90, a 5.26 percent decline and Jill’s ETF falls another 15.78 percent to $71.58 cents. On Wednesday the index goes down to 85; an additional 5.56 percent loss and Jill’s ETF declines to $59.65 cents for a total exposure of $178.95. On Thursday the index declines again by 5.88% and Jill’s ETF goes down another 17.64 percent to $49.12 cents for an exposure of $147.36 cents.<\/p>\n
Finally, on Friday the index drops to 75; an additional decline of 6.25 percent and Jill’s ETF again drops 18.75 percent. At the end of the week with five consecutive days of five-point declines in the benchmark index, Jill\u2019s ETF is worth $39.91 cents and her total exposure is just $119.74 cents.<\/p>\n
All told the benchmark index experienced a total decline of 25 percent for the week. The daily rebalance has reduced exposure each day and subsequent unfavorable index moves have created positive compounding. Jill’s investments still declined significantly at negative 60.09 percent, but not as much as three times the cumulative return of the index, negative 75 percent.<\/p>\n
Each day as part of the rebalancing process the fund pulled a portion of the assets out of the market to ensure that the fund\u2019s market exposure equals three times the fund\u2019s assets. The end result of this process is that Jill ended up losing less than she would have if the fund was not rebalanced each day.<\/p>\n