Leveraged ETF Effect On Big Move Days

Quantitative Trading: A leveraged ETFs strategy http://epchan.blogspot.ch/2012/10/a-leveraged-etfs-strategy.
html
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TRADING
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A leveraged ETFs strategy

In a post some years ago, I argued that
leveraged ETF (especially the triple
LABELS
leveraged ones) are unsuitable for
long-term holdings. Today, I want to Automated trading platforms
present research that suggests leveraged (13)
ETF can be very suitable for short-term Book reviews (3)

trading. factor model (9)
Strategies (17)
The research in question was just
published by Prof. Pauline Shum and her
collaborators at York University. Here is ERNIE CHAN
the simplest version of the strategy: if a

stock market index has experienced a V I EW M Y C O M P L ET E P R O FI L E
return >= 2% since the previous day's close
up to the current time at 2:15pm ET, then
MY BOOKS
1 of 26 3/30/2017 5:53 PM
Quantitative Trading: A leveraged ETFs strategy http://epchan.blogspot.ch/2012/10/a-leveraged-etfs-strategy.html
buy this index (via its futures, ETFs, or

stock components) right away, and exit at
the close with a market-on-close order. MY TRADING WORKSHOPS
Vice versa if the return is <= -2%. The
Options Strategies
annualized average return from June 2006
to July 2011 was found to be higher than
100%.
Now this strategy is actually quite PA R T N E R C E N T E R

well-known among institutional traders,
although this is the first time I see the
backtest results published. The reason why SUBSCRIBE TO MY BLOG
it works is also quite well-known: it has to Enter your Email

do with the fact that every leveraged ETF
need to rebalance at the market close in
order to keep its leverage constant (at x2 or
x3, depending on the fund). If the market
index goes up, the fund needs to buy the TWITTER
component stocks; otherwise, it needs to

sell stocks. If there is major market
movement (with absolute return >= 2%)
since the previous close, then the amount
of stocks that need to be bought or sold will
be correspondingly larger, resulting in
momentum in all those stocks near the
close. This strategy aims to front-run this
2 of 26 3/30/2017 5:53 PM
rebalancing to take advantage of the Tweets by @chanep

anticipated momentum. Ernest Chan
@chanep
Podcast of a recent interview of me:

It has been estimated that if the market rightmindtrader.com/podcast/episod
moves by 1%, the rebalancing could Episode 9: Why One Strategy

Facebook Twitter Google+ Pinte
account for up to 16.8% of the market-
rightmindtrader.com
on-close volume, so the induced
25 Mar
momentum can be substantial. Now who is
paying for this profits for those momentum Ernest Chan
@chanep
traders? Why, the buy-and-hold investors, Would it be a useful way of looking at trend following
as the strategy and mean reversion as the tac by
of course. This loss for the ETFs shows up Ernest Chan quora.com/Would-it-be-a-
as their tracking errors, resulting in a cost

Would it be a useful way of lo
of as much as 5% per annum for the Ernest Chan's answer: That wo
quora.com
buy-and-hold investors. Yet another reason
we should not be one of those investors! 23 Mar
Ernest Chan
@chanep
As Prof. Shum pointed out, if you trade this Embed View on Twitter
strategy live today, you will likely get a

lower return, because of all those
momentum traders who drove up the price
RECOMMENDED BOOKS
way before the close. However, there may
be an ameliorating factor at work here: this
momentum is proportional to the NAVof
the ETFs. As their NAV goes up with time
LINKS
(either due to additional subscriptions or
positive market returns), the returns of this QTS Managed Accounts
3 of 26 3/30/2017 5:53 PM
strategy should also increase. RSS Site Feed

Quantitative Research &
=== Trading
Now for some public service Quant News
announcements: Quantocracy
FactorWave
1) A company called Level 3 Data Corp sells
Eran Raviv (Quant Analyst at
proprietary data indicating buying and
large pension fund)
selling pressure on stocks. Their internal
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backtests show that adding these data to
High frequency historical data
some common stock trading strategies
essentially double their returns. An
explanatory video is available, and I heard BLOG ARCHIVE
they are offering 3-month free trials.
2017 (1)
2) The London Systematic Traders (LST) 2016 (4)

Club has asked me to say a few words 2015 (7)
about their new initiative to build a London
2014 (8)
centric collaborative community of traders,
2013 (11)
developers and researchers.
2012 (12)
LST aims to be at the intersection of November (1)
traders, developers and quants with a October (2)
strong emphasis community building and
A leveraged ETFs strategy
on knowledge exchange, providing a
Order flow as a predictor
trading networks with a very specific focus
4 of 26 3/30/2017 5:53 PM
on systematic, algorithmic (i.e. automated) of return

or quantitative trading.
August (1)
Membership is free and open to everybody July (1)

with an interest in the above topics. June (1)
April (2)
http://www.meetup.com/London-
March (2)
Systematic-Traders/
February (1)
On Friday, Nov 23, I expect to be hosting a January (1)
Q&A session with members of the LST (see
2 above) at the Apex Hotel in London. All 2011 (15)
are welcome. Please visit their website for 2010 (17)

details. 2009 (32)
2008 (28)
3) I will be conducting my Backtesting and
Statistical Arbitrage workshops in London, 2007 (50)
Nov 19-22, and look forward to seeing 2006 (24)
some of our readers there!
P O ST ED BY ER NI E C HA N AT 4: 31 P M
L A BEL S : ST R AT EG IES
39 COMMENTS:
GekkoQuant said...
5 of 26 3/30/2017 5:53 PM
Hi,
Interesting post & paper, I've been

playing around with a similar idea.
There are a fair few "quantitative
index" funds available by the big
banks where the strategy rules are
completely transparent and laid out in
the product book.
Essentially the books give you when

and what will be traded by the banks
however you don't know the capacity /
aum. It may be possible to front run
those orders ;)
FRIDAY , O C T O BE R 2 6, 20 1 2
AT 2 :2 1 :0 0 P M E D T
Ernie Chan said...
Hi GekkoQuant,
Very interesting thought ... do you
have an example ticker for this type of
funds?
Ernie
FRIDAY , O C T O BE R 2 6, 20 1 2
6 of 26 3/30/2017 5:53 PM
AT 2 :40 :0 0 P M E D T
GekkoQuant said...
https://ecommerce.barcap.com
/indices/action/indexDownload?id=-
385897bc8117656498aa61c2196331c5
&pageId=1
Page 90 on wards, lists some of

Barcap's equity indices including some
of the rules (if you can find the
factsheet for an index it is 100%
explicit in what the algo does).
FRIDAY , O C T O BE R 2 6, 20 1 2
AT 3 :56:0 0 P M E D T
Oddmund Grotte said...
Hi,
Very interesting blogpost. I've been

trading this pattern over the last year
but to be honest didn't fully
understand the dynamics behind it
before I came across your blog. Here is
7 of 26 3/30/2017 5:53 PM
my take on it:
http://www.quantifiedstrategies.com
/how-to-trade-momentum-in-spy-
during-the-last-hour/
S AT URD AY , O C T OB E R 2 7,
2 0 1 2 AT 6:2 5:0 0 AM E DT
Ernie Chan said...
Thanks, Gekkoquant.
My only reservation is that these
quant ETFs may not have large
enough NAV to generate momentum.
Let's hope for their continued success!
Ernie
2 0 1 2 AT 8:55:0 0 AM E DT
Ernie Chan said...
Thanks for the link, Oddmund.

Ernie
2 0 1 2 AT 8:56:0 0 AM E D T
8 of 26 3/30/2017 5:53 PM
x777 said...
Hi! I want to start studying algo

trading. How I can start from? I have 7
years expirience on futures/forex and
stock markets. Thank you!
2 0 1 2 AT 2:0 0 :0 0 P M E D T
Ernie Chan said...
x777,
You can read my book Quantitative
Trading as a start!
Ernie
2 0 1 2 AT 3 :0 9:0 0 P M ED T
x777 said...
Today Start. My english not good, but

I try. Thank you for writing it.
2 0 1 2 AT 7:57:0 0 P M E D T
Anonymous said...
I think you may have misread the
9 of 26 3/30/2017 5:53 PM
results. It looks like this strategy

returned over 100% over the period
studied and not per annum.
S UN D AY , O C T OB E R 2 8, 20 1 2
AT 8:0 3 :0 0 P M ED T
Ernie Chan said...
@Anon,
I calculated >100% based on Table 13.
It stated there that the average daily
return for Price-20 strategy is 0.0048,
which translates to 121% annualized.
Prof. Shum has read my post, and she

didn't raise any objections to my
interpretation.
Ernie
M ON D AY , O C T OB E R 2 9, 2 0 1 2
AT 8:3 6:0 0 AM E D T
Anonymous said...
Previous Anon again,
I don't see how a strategy that has
10 of 26 3/30/2017 5:53 PM
exposure for 2 hours per trade and

trades less than 130 times in 5 years
can achieve 100% per annum returns.
Figure 8 shows the strategy doubling
over about five years (although most
of the return is concentrated in
2008/2009). 100% overall is very
good for a strategy with such little
market exposure.
T UE SD AY , O C T OB E R 3 0 , 2 0 1 2
AT 2 :3 4:0 0 AM E DT
Ernie Chan said...
Anon,
You are right.
I checked with Prof. Shum again, and

she said Table 13 is based only on
those days when there were trades
executed. So indeed the 100% or so is
a cumulative return over 5 years.
Thanks for your vigilance!

Ernie
T UE SD AY , O C T OB E R 3 0 , 2 0 1 2
11 of 26 3/30/2017 5:53 PM
AT 1 1 :1 4:0 0 AM ED T
Anonymous said...
Nice returns but as mentioned above,

virtually all of the returns occur in
08-09. The cumulative returns look
very similar to daily mean reversion
strategies where you make money in
periods of extreme mkt volatility. It
can be nice to have these type of
strategies conditonal in your portfolio.
I.e. If vol reaches a certain level, you
put a positive weight on it.
Hank
FRIDAY , N O VEM B ER 2, 2 0 1 2
AT 2 :51 :0 0 P M E DT
Ernie Chan said...
Hank,
Good point - thanks!
Ernie
S AT URD AY , N O VE M BE R 3 ,
2 0 1 2 AT 8:41 :0 0 AM E D T
12 of 26 3/30/2017 5:53 PM
binary course guide said...
Great insights, Ernie. I've been

studying this trend for months now.
Your post made it a lot clearer now.
T UE SD AY , N O VE M BE R 6, 2 0 1 2
AT 2 :50 :0 0 AM E S T
Anonymous said...
The academics will destroy every

single edge traders can find for the
shake of publishing a paper. What a
waste of a mind.
WE DN E S DAY , N O VEM B ER 7,
2 0 1 2 AT 1 :56:0 0 P M E S T
Ernie Chan said...
Anon,
Actually, academics typically only
publish strategies that are already
well-known among institutional
traders. So I would say that is of net
benefit to retail traders. Our job as
traders is to find variations of these
strategies that are still profitable.
13 of 26 3/30/2017 5:53 PM
Ernie
2 0 1 2 AT 3 :5 4:0 0 P M ES T
Sam said...
I know this post is kind of out of place

but I thought one of you guys could
help me with ur suggestions. I'm
looking for a source where i could pull
market data & historical data for
Stocks, Futures, options along with
dividend data for stocks.
I'm looking for the cheapest ways and
am fine with delayed data up to a few
mins when it comes to real time.
S UN D AY , N O VE M BE R 1 1 , 2 0 1 2
AT 1 1 :3 0 :0 0 AM ES T
Ernie Chan said...
Sam,
Earnings.com offer dividend data.
csidata.com and Kibot.com offers
reasonably priced split/dividend-
adjusted historical data.
Your broker should provide you with
14 of 26 3/30/2017 5:53 PM
real-time or slightly delayed data at

very low cost.
Ernie
S UN D AY , N O VE M BE R 1 1 , 2 0 1 2
AT 1 2:2 2 :0 0 P M E ST
Unknown said...
hi:
thanks for the post and high quality
website. Sorry if I missed something
obvious, but is one supposed to buy
the non-leveraged index when it
moves 2% or the leveraged one [I
assume when the unleveraged index
moves 2%]?
thanks,
M ON D AY , N O VE M BE R 1 2,
2 0 1 2 AT 1 0 :2 9:0 0 P M E ST
Ernie Chan said...
@Unknown:
Yes, the 2% is the move for the
unlevered index.
It shouldn't matter whether you buy
15 of 26 3/30/2017 5:53 PM
the unlevered (SPY?) or the levered

product (3x ETF?)
Ernie
T UE SD AY , N O VE M BE R 1 3 ,
2 0 1 2 AT 8:21 :0 0 AM E S T
Unknown said...
thanks for clarification Ernie.

2 0 1 2 AT 9:0 8:0 0 AM E S T
x777 said...
I have finished reading your book.

Thank you for it! Which book you
advise to read next to develop?
WE DN E S DAY , N O VEM B ER 1 4,
2 0 1 2 AT 7:0 3 :0 0 AM E S T
Ernie Chan said...
Hi x777,
You can read any of Larry Connors'
books on my Recommended List.
Ernie
16 of 26 3/30/2017 5:53 PM
WE DN E S DAY , N O VEM B ER 1 4,
2 0 1 2 AT 8:1 2 :0 0 AM E S T
Anonymous said...
Hi Ernie,
I am backtesting a delta-hedged option

strategy but a bit worried about
transaction costs. I trade via IB. Do
you have any experience of costs
related to frequent delta hedging, at
least daily? I am considering trading
the 100 most liquid names.
Mike
FRIDAY , N O VEM B ER 1 6, 20 1 2
AT 1 :46:0 0 P M E S T
Ernie Chan said...
Hi Mike,
I have limited experience trading stock
options on IB.
Would you be able to use limit orders?
If not, you will have to observe the
average bid-ask spreads of those
17 of 26 3/30/2017 5:53 PM
options.
Ernie
FRIDAY , N O VEM B ER 1 6, 20 1 2
AT 3 :54:0 0 P M E S T
David said...
I find quant trading forums or

discussion groups interesting.
First of all, if you have a successful

quant strategy, the last thing you
ought to do is share it because if it's
good and a lot of people trade it, you
could eventually destroy it and make it
no longer profitable.
Second, I don't doubt that some of

these forums are used to lead people
astray. Again, like a magician, you
don't share your secret, otherwise,
you're no longer mystifying and
unique.
My strategies have outperformed the

S&P 500 for over five years now and
18 of 26 3/30/2017 5:53 PM
require little to no optimization or

maintenance. And by all means they
are kept secret.
2 0 1 2 AT 1 :3 9:0 0 P M ES T
Ernie Chan said...
David,
The base strategies this and other
trading forums discuss are well-known
to both professional traders and
academic researchers alike. The truly
creative and proprietary part is the
details of implementation and the
variations of the basic scheme.
Since the strategies are open to

everyone to backtest and verify for
themselves, I don't exactly know how
one can be "led astray".
Ernie
2 0 1 2 AT 1 :51 :0 0 P M E ST
Anonymous said...
19 of 26 3/30/2017 5:53 PM
David,
Outperforming S&P500 over the last 5

years isnt that great.
Whilst this blog has served to spark

more creative discussions on strategies
that are used by institutional
investors, your comments has no
accretive value at all.
Good on you that your model needs to

optimisation or tweaking. because
1) either you are a fool who believes in
his model totally
2) too dumb to make it better

2 0 1 2 AT 1 2 :57:0 0 AM ES T
Anonymous said...
Hi Ernie,
I have been reading about the different

ways a trader could manage other
20 of 26 3/30/2017 5:53 PM
people money and I am rather

confused from the different options. I
understand there are many different
terms and names including family
fund, hedge fund, investment fund,
etc, and each has its own commission
and fees structure (4% of investment +
20% of gains, only 4% of investment,
etc). I was wondering if you could
illustrate a bit about the differences
and advantages of each.
Thanks.

2 0 1 2 AT 1 :3 2:0 0 AM E ST
Ernie Chan said...
Hi Anon,
The typical fee structure is 2% of NAV
+ 20% of profits.
However, if you have a stellar

performance, you can negotiate a
higher fee.
Ernie
21 of 26 3/30/2017 5:53 PM

2 0 1 2 AT 8:1 0 :0 0 AM E ST
Clive said...
...leveraged ETF (especially the triple

leveraged ones) are unsuitable for
long-term holdings...
Provided you're prepared to

review/rebalance once per year or so
leveraged ETF's are fine for longer
term holdings.
Go to etfreplay.com and enter 50% in

SSO, 50% TIP and compare that to
100% SPY for any single year (2007
onwards) and you'll see relatively low
tracking error.
FRIDAY , N O VEM B ER 3 0 , 20 1 2
AT 1 1 :40 :0 0 AM ES T
Ernie Chan said...
Clive,
Besides tracking error, we are also
concerned with the fact that 3x
22 of 26 3/30/2017 5:53 PM
leverage is higher than the Kelly

optimal.
Ernie
S AT URD AY , D EC E M B E R 1 ,
2 0 1 2 AT 8:29:0 0 AM ES T
Aaron Musgrove said...
Hi,
I find all your comments extremely
fascinating so thank you for
participating. My question is regarding
long term versus short investing in 3X
leveraged etfs such as the UDOW. I get
the math regarding compounding but
if I held the UDOW from inception my
return to date would be enormous.
Could it be that one must either be a
short term buyer or a very very long
term investor with long only products?
T H URS D AY , SE P T EM B ER 1 0 ,
2 0 1 5 AT 2 :3 9:0 0 AM E DT
Ernie Chan said...
Hi Aaron,
Just because the long term growth
23 of 26 3/30/2017 5:53 PM
rate of a 3x levered product is less

than 3x the long term growth rate of a
1x product doesn't mean that it can't
deliver high return!
Ernie
T H URS D AY , SE P T EM B ER 1 0 ,
2 0 1 5 AT 9:1 8:0 0 AM E DT
Douglas Pegram said...
Ernie,
Do you have additional Algo ETF
strategies I can try out? Also, is there
an updated version of this strategy as
well? I am reading both your books
and working on setting up ETF algos
and want to backtest what you have so
far as a starting/jumping off point.
Thanks
Doug
M ON D AY , J UN E 2 7, 20 1 6 AT
1 1 :26:0 0 AM ED T
Douglas Pegram said...
Ernie,
Do you have an updated version of
24 of 26 3/30/2017 5:53 PM
this ETF strategy? Also do you have

any other ETF strategies I can
analyze? I am reading both of your
books and want to use your ETF
strategies as a starting point and for
backtesting analysis. Thanks
Doug
dougpegram@hotmail.com
M ON D AY , J UN E 2 7, 20 1 6 AT
1 1 :27:0 0 AM E DT
Ernie Chan said...
Douglas,
You can obviously try the same
strategy on many different ETFs and
different entry thresholds and times.
I am still working on researching other

ETF strategies.
Ernie
M ON D AY , J UN E 2 7, 20 1 6 AT
3 :0 4:0 0 P M E DT
25 of 26 3/30/2017 5:53 PM
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Quantitative Trading: A leveraged ETFs strategy http://epchan.blogspot.ch/2012/10/a-leveraged-etfs-strategy.

3 Mehr Nchster Blog Blog erstellen Anmelden

T H U R S D AY, O C T O B E R 2 5 , 2 0 1 2 SEARCH THIS BLOG

A leveraged ETFs strategy

ETF can be very suitable for short-term Book reviews (3)

the simplest version of the strategy: if a

buy this index (via its futures, ETFs, or

Now this strategy is actually quite PA R T N E R C E N T E R

it works is also quite well-known: it has to Enter your Email

component stocks; otherwise, it needs to

rebalancing to take advantage of the Tweets by @chanep

Podcast of a recent interview of me:

moves by 1%, the rebalancing could Episode 9: Why One Strategy

as their tracking errors, resulting in a cost

strategy live today, you will likely get a

strategy should also increase. RSS Site Feed

2) The London Systematic Traders (LST) 2016 (4)

on systematic, algorithmic (i.e. automated) of return

Membership is free and open to everybody July (1)

are welcome. Please visit their website for 2010 (17)

Interesting post & paper, I've been

Essentially the books give you when

Ernie Chan said...

Page 90 on wards, lists some of

Oddmund Grotte said...

Very interesting blogpost. I've been

Ernie Chan said...

Let's hope for their continued success!

Ernie Chan said...

Thanks for the link, Oddmund.

Hi! I want to start studying algo

Ernie Chan said...

Today Start. My english not good, but

I think you may have misread the

results. It looks like this strategy

Ernie Chan said...

Prof. Shum has read my post, and she

Previous Anon again,

I don't see how a strategy that has

exposure for 2 hours per trade and

Ernie Chan said...

I checked with Prof. Shum again, and

Thanks for your vigilance!

Nice returns but as mentioned above,

Ernie Chan said...

binary course guide said...

Great insights, Ernie. I've been

The academics will destroy every

Ernie Chan said...

I know this post is kind of out of place

Ernie Chan said...

real-time or slightly delayed data at

Ernie Chan said...

It shouldn't matter whether you buy

the unlevered (SPY?) or the levered

thanks for clarification Ernie.

I have finished reading your book.

Ernie Chan said...