What is an ETF?

Leveraged Indicators

Update : May 12, 2014

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1. What is a Leveraged Indicator?

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

2. Traits of Leveraged Indicators

Leveraged Indicators have price movements and returns that differ with those of regular indicators. The following is a specific explanation of the traits of TOPIX Leveraged (2x) Index.

(1) Traits

  • TOPIX Leveraged (2x) Index is calculated so that the fluctuation rate will be twice the daily fluctuation rate of TOPIX. Therefore, it will be 2x 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 2x that of TOPIX due to a compounding effect.
  • Particularly, in cases where TOPIX has repeated mutual rises and declines, the compound effect of TOPIX Leveraged (2x) Index is gradually decreased, causing returns to be more difficult to achieve.
  • TOPIX Leveraged (2x) Index is expected to produce even more dramatic returns when TOPIX is in an upward trend, making it particularly useful when such a trend is expected.

(2) Notes

<Example 1: An Upward Trend for the Underlying Indicator>

The graph below shows a case of the underlying indicator TOPIX on the rise. In such a case, TOPIX Leveraged (2x) Index will have a daily fluctuation rate that is twice that of the underlying indicator.
However, if a period of 2 business days or longer (Base date to 2nd day) is examined, whereas TOPIX rose 15.5% (100 to 115.5), TOPIX Leveraged (2x) Index rose 32% (100 to 132), producing a result that is not exactly 2x the fluctuation rate of the underlying indicator.
In this way, it is possible to aim for higher returns than market gains using a Leveraged Indicator. However, when compared over a period of 2 business days or longer, the rate of increase may differ from the expected fluctuation rate (2x 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 Leveraged Indicator.

<Example 2: A Downward Trend for the Underlying Indicator>

The following graph shows a case of the underlying indicator TOPIX on the decline. In such a case, TOPIX Leveraged (2x) Index will have a daily fluctuation rate that is twice that of the underlying indicator.
However, just as in Example 1, if a period of 2 business days or longer is examined, whereas TOPIX fell 14.5% (100 to 85.5), TOPIX Leveraged (2x) Index fell 28% (100 to 72.0), producing a result that is not exactly 2x the fluctuation rate of the underlying indicator.
In this way, the Leveraged Indicator produces a larger decline than that of the market. However, when compared over a period of 2 business days or longer, the rate of decline may differ from the expected fluctuation rate (2x 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 Leveraged Indicator.

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

The following graph shows a case of TOPIX experiencing a series of gains and losses. In such a case, TOPIX Leveraged (2x) Index will again have a daily fluctuation rate that is twice that of the underlying indicator.
However, though TOPIX has returned to the base date’s level by the 3rd day, TOPIX Leveraged (2x) 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, a Leveraged Indicator’s performance will be gradually decreased compared to that of the underlying indicator due to the compounding effect.

<Example 4: When an ETF/ETN's price in the market reaches the upper limit price >

The diagram below shows the price of an ETF/ETN tracking TOPIX Leveraged (2x) Index reaching its upper limit price. While the price of the issue is capped at this upper limit price during the day, TOPIX Leveraged (2x) Index may continue to rise beyond this level since it is not subject to quoting restrictions. This means that the issue cannot be traded in the market at or near its theoretical price if the theoretical price rises above the upper limit price.
Such situations where the price in the market is different from its theoretical price can occur for any ETF/ETN regardless of whether it tracks a Leveraged Indicator. However, in the case of a Leveraged Indicator, its leveraged nature means that an issue tracking the indicator would be more likely to reach the upper limit price due to the fluctuations in its market, creating a gap between theoretical and tradable prices. Investors should bear in mind that a higher likelihood of the tradable price deviating from its theoretical price.
Once the theoretical price of the ETF/ETN falls to or below the upper limit price, the price in the market will no longer deviate from its theoretical price.

<Example 5: When an ETF/ETN's price in the market reaches the lower limit price >

The diagram below shows the price of an ETF/ETN tracking TOPIX Leveraged (2x) Index reaching its lower limit price. While the price of the issue cannot fall beyond this price during the day, TOPIX Leveraged (2x) Index may continue to fall below this level since it is not subject to quoting restrictions. This means that the issue cannot be traded in the market at or near its theoretical price if the theoretical price falls below the lower limit price.
Such situations where the price in the market is different from its theoretical price can occur for any ETF/ETN regardless of whether it tracks a Leveraged Indicator. However, in the case of a Leveraged Indicator, its leveraged nature means that an ETF/ETN tracking the indicator would be more likely to reach the lower limit price due to the fluctuations, creating a gap between theoretical and tradable prices. Investors should bear in mind that this would result in a higher likelihood of the tradable price deviating from its theoretical price.
Once the theoretical price of the ETF/ETN rises to or above the upper limit price, the price in the market will no longer deviate from its theoretical price.

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

Compared to an ETF tracking the underlying indicator, because the daily fluctuation rate is amplified for an ETF tracking a Leveraged Indicator, the profit/loss will also be amplified.

4. Notes on Investment Styles

  • In cases of medium to long-term investment, the disparity between the underlying indicator’s fluctuation rate and the Leveraged 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 Leveraged Indicator may be gradually diminished compared to the underlying indicator due to a compound effect, making profits difficult to achieve.

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