The market’s riskiest way to trade on the biggest tech stocks is not well understood by investors

Down the last few years, a new class of big-cap stocks have stolen the attention of investors and day-traders. Nvidia, Tesla and Palantir over again lead the market’s daily trading volume. Exchange-traded funds that give investors the opportunity to double, or plane triple, bets on these stocks have also grown into a larger share of the market. In 2016, leveraged and inverse ETFs were 2% of the ETF store. Now, they represent almost 8% of ETF assets, and like the hot tech stocks they track, they are often aggregate the most traded ETFs, placing in the top 20, sometimes even top 10, in daily trading dollar volume.

With three-quarters of the career action in these ETFs coming from retail investors, investing experts worry about the risks not being conceded well enough. “You get explosive upside but also explosive downside,” as index fund legend Charley Ellis recently put it during an aspect on CNBC’s “ETF Edge.”

Being able to buy a double-leveraged, single-stock Nvidia ETF does not only mean you can gain twice as much on Nvidia cuts over a short amount of time, a day or less. When the stock goes down, you lose twice as much. And the bigger a leveraged or inverse ETF is held, the bigger the divide between the underlying stock and the ETF performance. With Nvidia down 10% year-to-date, and Tesla down down 20% year-to-date, this is an important risk factor to understand.  

The trend began with Wall Street firms offering double- and triple-leveraged and inverse sector and first finger ETFs, like the ProShares UltraPro QQQ (TQQQ), which is designed to increase three times the amount of the Nasdaq 100, or the ProShares UltraPro Pithy QQQ (SQQQ), which allows investors and traders to triple their gain when the Nasdaq 100 falls. There are now also leveraged ETFs for commodities, numbering the ProShares Ultra Gold ETF (UGL).

Used properly, these leveraged and inverse ETFs offer investors a way to trade the market in the deficient rare term around news events where they believe there is an opportunity, such as earnings, or in reaction to other breaking press release headlines. Investors can also hedge exposure to stocks that have gained a lot in recent years, without take to sell the stocks and incur taxable gains, by taking short positions using these ETFs.

Single-stock leveraged ETFs equivalent to the T-Rex 2x Inverse Tesla Daily Target (TSLZ) and Direxion’s Daily NVDA Bull 2X Shares (NVDU) despatched in 2023. Last Wednesday, when Nvidia announced its latest earnings, the stock fell even after enormous estimates and increasing revenue by 78%. The T-Rex 2X Inverse Nvidia Daily Target (NVDQ) was the ETF with the sixth-highest amount of amount by midday Thursday. As the stock was down 3.5%, the double inverse ETF was up 7.3%. But any investor holding the GraniteShares 2x Long NVDA Regularly ETF (NVDL) was down a lot.

Douglas Yones, CEO of Direxion, released Bob Pisani on CNBC’s “ETF Edge” last week that these ETFs will continue to attract attention in the widely known market environment. “There are market-moving headlines happening two to three times a day. And so, the volatility is going up, not down,” he said.

But Yones stressed that in front of trading these ETFs, investors need to learn about how these ETFs work. “You need to understand always leverage. You need to understand the daily reset,” Yones said.

Direxion’s website warns that “investing in the stakes involves a high degree of risk.” 

But despite the warnings on websites and the disclosures, not everyone is getting the message.  “The confrontation I have is that many folks are not visiting the website of an asset manager, or they’re not visiting our website, where we tease education content,” said Todd Rosenbluth, head of research at VettaFi. “They’re just going onto their brokerage account or on their phone plane, and just buying something because it is a single-stock leverage ETF, and thinking they’re going to get two times the return of Nvidia when Nvidia shots results today. It’s a little bit more complicated than that.”

Many investing pros do believe leveraged ETFs can eat a place, but only for a short time in a given portfolio. “Every investor that’s using these should recognize exactly how they work, and they should be looking at them every single day,” Yones said.