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

Over the last few years, a new class of big-cap stocks have stolen the attention of investors and day-traders. Nvidia, Tesla and Palantir often lead the market’s daily trading volume. Exchange-traded funds that give investors the opportunity to double, or even 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 market. Now, they represent almost 8% of ETF assets, and like the hot tech stocks they track, they are often among the most traded ETFs, placing in the top 20, sometimes even top 10, in daily trading dollar volume.

With three-quarters of the trading action in these ETFs coming from retail investors, investing experts worry about the risks not being understood well enough. “You get explosive upside but also explosive downside,” as index fund legend Charley Ellis recently put it during an appearance 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 shares over a short amount of time, a day or less. When the stock goes down, you lose twice as much. And the longer 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 over 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 index ETFs, like the ProShares UltraPro QQQ (TQQQ), which is designed to increase three times the amount of the Nasdaq 100, or the ProShares UltraPro Short QQQ (SQQQ), which allows investors and traders to triple their gain when the Nasdaq 100 falls. There are now also leveraged ETFs for commodities, including the ProShares Ultra Gold ETF (UGL).

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

Single-stock leveraged ETFs like the T-Rex 2x Inverse Tesla Daily Target (TSLZ) and Direxion’s Daily NVDA Bull 2X Shares (NVDU) launched in 2023. Last Wednesday, when Nvidia announced its latest earnings, the stock fell even after surpassing estimates and increasing revenue by 78%. The T-Rex 2X Inverse Nvidia Daily Target (NVDQ) was the ETF with the sixth-highest amount of volume 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 Daily ETF (NVDL) was down a lot.

Douglas Yones, CEO of Direxion, told Bob Pisani on CNBC’s “ETF Edge” last week that these ETFs will continue to attract attention in the current 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 before trading these ETFs, investors need to learn about how these ETFs work. “You need to understand daily leverage. You need to understand the daily reset,” Yones said.

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

But despite the warnings on websites and the disclosures, not everyone is getting the message.  “The challenge I have is that many folks are not visiting the website of an asset manager, or they’re not visiting our website, where we have education content,” said Todd Rosenbluth, head of research at VettaFi. “They’re just going onto their brokerage account or on their phone even, 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 reports results today. It’s a little bit more complicated than that.”

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