Trade Update - DXO, DIG, FAZ

It's been a long time since I've updated this blog, but I actually haven't done any trades until recently anyway.

Yesterday I sold most of my DXO at $4.85 and the rest of my DIG at at $30.24.

Oil is up to $74 and I decided to get out. I made about 15% on the DXO trade - not very much, but I had a LOT of money in that trade.

I'm a little disappointed. I said that holding DXO would be an easy 100% gain, and it should've been (DXO went below $2 a couple of times and is now about $4.85). I bought too much too early on the way down and had no more money left to buy when it was really low. Even with not timing it well, I still actually made about 30%, if we're just talking in US dollars. What really hurt me was the change in exchange rate. Most of my DXO was bought when the Canadian Dollar was at a low $0.78 to the US dollar, and now it's at $0.93. So I "lost" over 10% in gains due to the Canadian dollar skyrocketing. Due to "the constant leverage trap" with leveraged ETFs/ETNs, DXO did not perform as well as it could have if it didn't drop so low at the beginning. It also switched over to using the July 2010 futures contract as its basis, which has way more premium built in to it, meaning it wouldn't perform as well as near-term contracts assuming oil only moves up slowly.

So why'd I get out? Oil recovered nicely to $75 as expected, but I don't see reason for it to go much higher right now. The economy still sucks and the markets are irrationally optimistic -- the markets have been in a huge extended rally, so I thought I would get out while things are good before the next "storm" hits. I'm not saying oil won't keep going up. I just don't want to bet on it doing so. I think Oil will do really well long-term, but short-term, I'm too scared and so I'm taking my profits. I would consider re-entering if oil drops to $60.

FAZ - let's not even mention that. Worst trade ever. I'm still holding some of it which is pretty much worthless right now. Again, FAZ/FAS are only for day traders. They both lose money over the long term and are too volatile for non-day-traders to be playing. Luckily I didn't put much money into that, so my gains on DXO still far exceeded those loses.

On DIG, I believe I made just a couple of percent on the last 1/3 of my position that I sold. So I've averaged about a 25% gain on my full DIG position.

What's next? I'll save that for my next post.

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....

FAZ

I bought some FAZ (3x inverse financials) near the end of Friday at 15.93. The market kept rising in the last 10 minutes and FAZ closed at 15.60.

It's of course a risky trade, being a 3x leveraged fund, and I'm buying in the midst of a rally. In one month, the Dow has gone from 6600 up to 8000, and FAZ has dropped from over $100 to it's current value of around $16. The trade is a gamble, but I'm betting that after a month of large gains, the markets will pullback here, especially since the Dow has now reached the key resistance level of 8000. It could fly through it -- anything's possible -- but I think it's much more likely to get stuck around the 8000 range or bounce off it. It's been a pretty large rally and the economic news is still pretty dismal. Earnings season is now here (roughly from Tuesday to 6 weeks later), and the news should be bad.

Take a look at the chart below to see the Dow 8000 and 9000 resistance/support levels:



I think one of the riskier things about this trade is that I'm buying pretty early, without any confirmation of a change in direction of the markets. I probably should have waited to see if the DOW blows through 8000 or starts to drop. Instead, I'm trying to time the top perfectly, which usually doesn't work out too well :)

I don't want to set a stop on this trade, because the 3x ETFs are so volatile it would probably get hit and I would lose money now matter which way the trade eventually goes. I'm pretty confident DOW won't go above 8400 right now. I'm planning to sell in 2-3 days.