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July 14th, 2011, 11:10 AM   #1
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Double Leverage ETFs

You often here on business channels that Double leverage ETFsare not good for long term investing because if the stock growth is purely random the gains are always less than the losses. That is if you gain 10% then loose 10% you are down 1%

1.*0.9=0.99

However, consider four possible outcomes:

Gaining 10% twice: 1.1*1.1=1.21
Gaining 10% then loosing 10% 1.1*0.9=0.99
Loosing 10% then Gaining10% 0.9*1.1= 0.99
Loosing 10% twice in a row: 0.81

If you add all these outcomes up and then divide by four you get an average return of 1. That is on average in this purely random scenario one breaks even. However, of the investors loose.
Therefore on average double leverage does not reduce profits even though the longer you stay in the fund the further away you will get from obtaining twice the market return. If one has a collection of double leverage funds which were statistically independent, some of these risks could be mitigated by suitable rebalancing.

Given stocks typically have a daily volitility of 26% there are plenty of opportunities to rebalance a porfolio.
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