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Monday, August 3, 2009

Restricting access to leveraged ETFs, are brokerages outlawing products or strategies?

As more brokerages prevent their customers (read: individual investors) from trading leveraged ETFs, I am moved to question the motivation of these firms.

Thus far, we have UBS, Edward Jones, LPL Financial and Ameriprise Financial all banning trading of ETFs from ProShares and Direxion. Moreover, the Massachusetts chief financial regulator has announced an investigation of leveraged ETFs.

Further stirring the pot, FINRA issued a warning that these ETFs are not suitable for investors who hold them for longer than one day. If they are held longer than a day they would only be appropriate if "closely monitored by a financial professional."

The evidence against leveraged ETFs --

The beef against these ETFs is that you can get the call on a sector or index correct and still lose money. The examples used over and over again are the ProShares UltraShort Financial ETF (SKF) and the ProShares UltraShort Real Estate ETF (SRS). Despite the financial and real estate sectors taking a dive in 2008, an investor who held these ETFs for the entire year would have lost money rather than achieving a comfortable gain.

Then there are the 3X ETFs from Direxion. The products do indeed exhibit some extreme behavior and are probably best suited for very brief trades.

The implications --

The defenders of leveraged ETFs are many. Their main argument is that an appropriate strategy is necessary in order to make money with these ETFs. Sure, they work for day traders and swing traders but the evidence also exists that when a solid trend is underway and volatility is moderate to low, the 2X ETFs can easily be held for weeks or months; ie, as long as the trend is in force. And the profits under such conditions can be substantial. (In fact, those conditions are prevalent in the market right now.)

Uh oh. Trend followers are essentially the same as market timers. It is a generally accepted truth among financial advisors that market timing isn't appropriate for individual investors. Or is it?

Has there ever been a brokerage that discouraged market timers or day traders? Right or wrong, market timers and day traders generate commissions and commissions are the lifeblood of a brokerage.

So brokerages attack leveraged ETFs with a big dose of hypocrisy. If I am a lousy market timer, it’s OK to squander my funds on stocks, options or standard ETFs but it's not OK to lose my money on leveraged ETFs.

Are brokerages banning day trading or market timing? Never happen. Even though there is plenty of evidence that many individual investors are not particularly adept at these trading strategies.

Will brokerages ban leveraged ETFs to make it look like they actually have the best interests of investors in mind? After more than a year where so many financial advisors failed to help investors avoid steep losses, this move is a cynical attempt to detract investor attention from the fact that brokerages did little or nothing to guide or protect investors during the worst market downturn in decades. This is hypocrisy, not protection for investors.

As 2-Pac used to say: "In a position to make a difference, politicians and hypocrites they don't wanna listen."

Disclosure: long ROM,USD and UYG

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