Retail investors jump into risky leveraged ETFs to ride wild 2022 so far in markets

Published Fri, Apr 8 202210:26 AM EDTUpdated Fri, Apr 8 202210:44 AM EDT

Many professional traders say that despite overall negative returns the first quarter of 2022 was one of the best pure trading atmospheres they've ever seen. But retail investors trying to play along with the pros are developing a potentially dangerous hobby using leveraged funds. The S & P 500 had 32 sessions, more than half the trading days of the first quarter, that saw an up or down move of more than one percent — the second highest in more than a decade. The market saw volatile swings as traders and investors dealt with the increasing probability of rate hikes, decades-high inflation and Russia's invasion of Ukraine causing an energy prices spike. That volatility invited traders with a higher risk appetite to try and take advantage of wild price swings on both sides of the ups and downs. According to Nasdaq Data Link, the PROShares UltraPRO QQQ (TQQQ) , which multiplies the Nasdaq 100 's performance by three and the ProShares UltraPRO Short (SQQQ) , which tracks the opposite of the Nasdaq 100's move and multiples it by three were among the top stocks or ETFs favored by retail traders in the first quarter of this year. The TQQQ was the 7 th most heavily traded equity among retail traders, the SQQQ ranked 10 th . Both products are made by ProShares. In the first quarter, the SQQQ had 19 days where more than 100 million shares were traded. The number was almost twice as high for the bullish triple leveraged TQQQ. By comparison over the last 100 days, 97 million shares of Apple were traded on average. Buyer beware The SQQQ and TQQQ have expense ratios of about one percent, making them relatively expensive products. That's also one of the reasons why over periods of time, the products don't fully deliver triple leveraged returns and why they can deliver greater than triple leveraged losses. For instance the TQQQ was down 30% in the first quarter of this year, more than three times the 8.8% drop suffered by holders of the QQQ which mirrors the Nasdaq 100. If you bought the SQQQ at the start of the quarter you'd be up 13.3%, not even close to the triple benefit implied in the product compared to a straight inverse of the QQQ. The Psychology Behind Leverage Most experts advise these funds should only be used to hedge a portfolio over short periods of time, but market behavioral economists warn the general public still needs more advice about how to not get caught in a leveraged ETF trap. Professor Hersh Shefrin studies risk at Santa Clara University's Business School and said in a recent interview he believes leveraged ETFs should only be used by skilled and experienced retail traders. Shefrin said "the demand for highly skewed bets is pervasive because there's a strong motivation for humans to bet big and win big." Shefrin studied Americans with gambling addiction and compared them to the proportion of traders who "are extreme from a risk perspective" and found both categories represented about 2.5% of their respective populations. But as far as the retail investor is concerned, the disparity in promised returns versus the reality may matter less than the gambling itself. Professor Brad Barber studies investor psychology in the University of California-Davis' School of Business and said "attention provided by the traditional media and social media to big market moves captures the attention of the retail investor and draws them to low probability but high payoff events and these events can be fun and thrilling and mimic the feeling you might have from winning a bet and while that aspect of trading has always been around these type of leveraged products make winning big seem more accessible." Barber also said the products aren't the only thing leading to the thrill for many retail investors. The modern day stock buying process allows for it as well in that traders and investors used to have to mail in a form to open a brokerage account. Then they had to call a broker to make an order. Now you can do everything with a few clicks online allowing for more spontaneity and a greater, immediate rush. ProShares did not respond to emails or calls when asked why their leveraged ETFs were gaining in popularity. Neither market behavioral expert believe increased regulation is the answer. They both advocate, that people who like leveraged products impose self-discipline by only allocating a small portion of their portfolio to these kinds of highly volatile investment products. Professor Shefrin added investors of different eras have always had other ways to add risk. In the 1920s "retail investors used margin" said Shefrin, "so much so that when the market crashed in 1929 a vast majority were wiped out leading to new regulation in the 1930s." A few decades later the invention of options satisfied the hunger for added risk, and now leveraged ETFs are taking a greater share of the pie.