What is an ETF?

Inverse Indicators

Update : Oct. 29, 2012

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1. What is an Inverse Indicator?

An Inverse Indicator is an indicator calculated by multiplying the daily fluctuation rate of the underlying index (TOPIX, etc.) by a certain factor.

2. Traits of Inverse Indicators

(1) Traits

Inverse Indicators have price movements and returns that differ with those of regular indicators. The following is a specific explanation of the traits of the TOPIX Inverse (-1x) Indicator.

  • The TOPIX Inverse (-1x) Index is calculated so that the fluctuation rate will be -1x the daily fluctuation rate of TOPIX. Therefore, it will be -1x if compared to the TOPIX fluctuation rate for the preceding business day, however for periods longer than two business days, the fluctuation rate may be more or less than -1x that of TOIPX due to a compounding effect.
  • Particularly, in cases where TOPIX has repeated mutual rises and declines, the compound effect of the TOPIX Inverse (-1x) Index is gradually decreased, causing returns to be more difficult to achieve.
  • The TOPIX Inverse (-1x) Index is expected to produce gains when TOPIX is in a downward trend, making it particularly useful when such a trend is expected.

(2) Notes

<Example 1: A Downward Trend for the Underlying Indicator>

The graph below shows a case of TOPIX in decline. In such a case, the TOPIX Inverse (-1x) Index will have a daily fluctuation rate equal to -1x that of the underlying indicator.
However, if a period of 2 business days or longer (Base date to 2nd day) is examined, whereas TOPIX fell 14.5% (100 to 85.5), TOPIX Inverse (-1x) Index rose 15.5% (100 to 115.5), producing a result that is not exactly -1x the fluctuation rate of the underlying indicator.
In this way, it is possible to aim for returns during a declining market using an Inverse Indicator. However, when compared over a period of 2 business days or longer, the rate of increase may differ from the expected fluctuation rate (-1x the underlying indicator). The longer the period of investment, the greater the possibility for discrepancy between the fluctuation rates of the underlying indicator and the Inverse Indicator.

<Example 2: An Upward Trend for the Underlying Indicator>

The following graph shows a case of TOPIX on the rise. In such a case, the TOPIX Inverse (-1x) Index will have a daily fluctuation rate that is -1x that of the underlying indicator.
However, just as in Example 1, if a period of 2 business days or longer is examined, whereas TOPIX rose 15.5% (100 to 115.5), TOPIX Inverse (-1x) Index fell 14.5% (100 to 85.5), producing a result not exactly -1x the fluctuation rate of the underlying indicator.
In this way, the Inverse Indicator produces a decline when the market is on the rise. However, when compared over a period of 2 business days or longer, the rate of decline may differ from the expected fluctuation rate (-1x the underlying indicator). The longer the period of investment, the greater the possibility for discrepancy between the fluctuation rates of the underlying indicator and the Inverse Indicator.

<Example 3: A Trend of Repeated Gains and Losses of the Underlying Indicator>

Finally, the following graph shows a case of the underlying indicator TOPIX experiencing a series of gains and losses. In such a case, the TOPIX Inverse (-1x) Indicator will again have a daily fluctuation rate that is -1x that of the underlying indicator.
However, though TOPIX has returned to the base date’s level by the 3rd day, the TOPIX Inverse (-1x) Index moved from 100 to 98.6, not recovering to the base date value due to its compounded movements.
In cases where the market’s direction is unclear and the underlying indicator repeatedly rises and falls, an Inverse Indicator’s performance will be gradually decreased compared to that of the underlying indicator due to the compounding effect.

3. Differences in Profit/Loss with ETFs tracking Underlying Indicator

Inverse Indicators are calculated to produce -1x the daily fluctuation rate of the underlying indicator, and thus profit and loss will be reversed.

4. Notes on Investment Styles

  • In cases of medium to long-term investment, the disparity between the underlying indicator’s fluctuation rate and the Inverse Indicator’s fluctuation rate may increase greatly.
  • When market conditions are such that the underlying indicator will rise and fall repeatedly, the performance of the Inverse Indicator may be gradually diminished compared to the underlying indicator due to a compound effect, making profits difficult to achieve.

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