Argggggh...

Well FAZ dropped 41% in one day! That's probably one of the biggest one-day moves ever of one of these leveraged ETFS. And I didn't sell - stupid me. Here's what went down.:

I bought FAZ perfect timing, and the markets gradually dropped the next 3 days. I was up about 15% on Wednesday and thought about selling, but decided to wait one more day. And then out of nowhere -- Wells Fargo sends out a pre-release announcement about their expected earnings. Maybe I'm just not paying attention, but I didn't know this was going to happen. Their earnings statement date isn't until April 22nd, one of the later ones in fact, and here they go letting their numbers out before any of the other banks. And of course the news was really good. Here's the deal: Wells Fargo was always one of the healthiest banks out there. They didn't get involved in any subprime loaning, they didn't need any bailout money (but got some like all banks), and so of course they're doing well! I'm no conspiracy theorist, but this was obviously all planned out to downplay the bad news of bad banks. I bet some serious institutional money was thrown into the markets timed with the release to help spur this rally. Seriously, everyone is over-reacting to the news, but I guess everyone wants a rally.

If I knew there was any news coming out, I would've gotten out. That was my plan as you could see from my last post. But I also said I would only hold 2 - 3 days, and I didn't get out when I should have. I should have at least set a stop at my break-even point, and even with the huge gap down, I would have only lost about 15%. I even still had time to sell Thursday morning, and I actually considered switching to FAS to try to recover my losses (which would have worked becase FAZ was down 20% at the beginning of the day, and ended down 41%, and so I would've made about 20% on FAS just in the last half of the day).

I should've sold no matter what, because I'll never break even. Huge drops like this are horrible to recover from in leveraged ETFs which have to match the *daily* performance of an index. Here's an example to show why:

Say some index is at 100 and it's inverse 3x ETF (e.g. FAZ) is at $100. Say the index goes up 14% in one day, meaning the 3x ETF drops 3*14 = 42% (like FAZ did). The index would now be at 114 and FAZ would be at $58. Now say the index returns to it's previous level the next day. This would require only about a 12% drop (114 * (1 - 0.12) = ~100). That means FAZ would increase 12*3 = 36%. FAZ would end up at $58 * 1.36 = ~$79. So while the market has returned to where it originally was, the holder of the 3x ETF is down 21%.

Let me re-iterate this: Even if the markets return to their previous level the very next day, the holder of the 3x ETF is down 21% !!! This is why huge movements in ETFs are so detrimental, and also why you do not want to own them long-term. This is known as the "Constant Leverage Trap". You can read more about this here.

Bah. Luckily I didn't put too much money into this, but I did put in more than I should've for such a risky play. I really need to start learning from these mistakes. I even said last time that FAS/FAZ were too crazy and you have to be a day trader to use them... and then I jumped back in anyway and got burnt again. Sigh....