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Why The Motley Fool needs to do something about 3x ETF's on CAPS



September 14, 2011 – Comments (15) | RELATED TICKERS: TMF

I've argued before that shorting pairs of 3x leveraged ETF's is not free money, as some have thought. However, red thumbing them on CAPS is free points, and better yet, free accuracy (yay! I'm 90% accurate!). Without facing a margin call, the CAPSter can wait out any prolonged unidirectional move on one side of one or two pairs while the other side makes him "accurate" over and over again and the other pairs make him very accurate, and the points will, on balance, probably work out okay for him too, especially since closing picks and reopening them puts compounding to work for you on red thumbs in CAPS. 

All this makes some players appear to be much better investors than they really are. I confess I used to do this, until I realized that the accuracy of CAPS rankings, and more still, the subsequent stock ratings, are far more important to me than any benefit I get from accuracy juicing. So I am no longer part of the problem, but unlike TMFJake and TMFCHarris, I have no idea where to begin to become part of the solution.

Please, let's figure out a good way to eliminate 3x leveraged ETF shorting from player rankings, and make CAPS a better tool for us all.

15 Comments – Post Your Own

#1) On September 14, 2011 at 1:06 PM, Momentum21 (96.94) wrote:

I agree with the fact that many have "gamed" these 3xers and I would not be sad to see them marked unratable.


There are plenty of ways one could game the system or try to "appear to be a much better investor than they really are" would then have to address each of those including: 

1. setting up an alias each time the market reaches a high or low

2. downthumbing unshortable PKs 

3. eliminating the ability to back in and out of trades within the 20 min delay


The only way to truly demonstrate one's investing ability is to use real money since managing your "bank" will never be able to be measured on can you accurately assess how you would truly act when the market takes away 30% of your hard earned money in 1 month?? You just can't do that in a simulation. 

3xers are like the 3 point shot in basketball. It changes the nature of the game for sure but it also adds some excitement that keeps many people interested.

What's amazing is that many people still think 3xers are good investments in real life! If anything this is a great case for keeping them around as a lesson to the community. : )

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#2) On September 14, 2011 at 1:32 PM, chk999 (99.96) wrote:

The levered ETFs have validity as trading vehicles as long as you understand their limitations.

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#3) On September 14, 2011 at 1:50 PM, Momentum21 (96.94) wrote:

#2 - Of course they have "validity"...

If you have the ability to understand the underlying derivatives I would imagine you could replicate the trade or hedge more effeciently, no? 

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#4) On September 14, 2011 at 2:04 PM, XMFCrocoStimpy (97.52) wrote:


I am working on an analysis of the 3x and 2x ETFs, particularly the inverse flavor of each, to determine if they are substantively detrimental to CAPS or merely an annoyance.  I say "merely" not to minimize how some people feel about them - from my personal perspective, I don't see them as particularly insightful instruments - but if they are not demonstrably negative impacts it is difficult to justify removing them from the CAPS universe.

As usual I'll state the basic premise of CAPS, which is that it is a stock PICKING game, not an investment game.  Investment games necessarily include strategic uses of stock picks, but stock picking is not constrained by investment management.  That said, knowing that a levered ETF has a tendency to decay in value the longer you hold it doesn't provide much insight since that is intrinsically their nature, so if that is the only take-away from these instruments that we get from CAPS then they don't add too much to our community knowledge.

Fool On,


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#5) On September 14, 2011 at 2:57 PM, 100ozRound (28.51) wrote:

See that's where I'm confused - games have winners and this game is really open ended.  I look at this as a stock RATING service and we could find better investments based on the community consensus of a stock. Isn't that what it's all about?  If a 3x ETF is garbage and people red thumb it, won't that do more to help people avoid it based on the ranking?

Of course I could be wrong, after all, I've never red thumbed anything since I've been on this site.


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#6) On September 14, 2011 at 4:28 PM, XMFCrocoStimpy (97.52) wrote:

100ozRound, I'm assuming your comment is directed to my response #4?  The analysis that I am in the process of running is to determine if the Ultra ETF class is having a negative impact on the ratings of other stocks.  Why I find them somewhat un-informative by themselves is because they have a strong inherent decay - that is, if the underlying index doesn't change at all, they will still lose value on a regular basis.  Since we don't need the community to tell us this, I'm looking to see if it is that aspect of their performance that dominates the ratings they get or if people are using them to make more informative picks about the anticipated direction that their underlying indices will move.

What many people are concerned about is not that these are listed as garbage per se, but that players are pumping their scores up substantially by taking advantage of some of the statistical quirks of the leverage and the scoring system in CAPS.  Again, by itself this wouldn't be bad because the players who do this and achieve a high CAPS score (and ultimately higher influence on the CAPS ratings) only have their CAPS rating applied to their own picks, so if all their picks are leveraged ETFs then there is no impact on other parts of the CAPS system.  However, if you were to pump up your CAPS score with these securities and then start picking lots of other regular stocks, you could find a situation where someone is great at using the Ultra ETFs but is terrible at stock picking, but is still achieving a very high CAPS rating because they keep some portion of their picks going with the Ultras.

We err on the very conservative side when it comes to things like removing anything from the CAPS universe, but the analysis is worthwhile to help quantify the impact of these instruments on the overall CAPS universe.

Fool On,


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#7) On September 14, 2011 at 4:59 PM, 100ozRound (28.51) wrote:

No, it wasn't directed at you specifically.  But thanks for clarifying how they work within this system and how people benefit from their inherent flaws and exploit the inefficiencies in the system.

You should have a new charm - the garbage can - for those who pick Ultrashort ETFs as 20% (or so) of their portfolio!


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#8) On September 14, 2011 at 5:06 PM, truthisntstupid (79.66) wrote:

+1 rec for the garbage can

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#9) On September 14, 2011 at 7:04 PM, FleaBagger (27.52) wrote:

Thanks, Xander, for addressing this and answering 100oz's question with almost exactly what I was going to say. Since I'm no TMF employee, I can be more brazen in my assertion that this is absolutely happening, and of the top 20 underperform players (new category - check it out) only 2 (10%) have not used this strategy. If you want to know who is good at picking stocks to go up, select the top outperform players. If you want to know who is good at picking stocks to go down, good luck. I don't know much about .pk's, but if it is as easy as Momentum says, nobody in the top 20 underperform players is getting their underperform points the hard way.

And yes, if this is making it nearly impossible to find a good stock shorter on CAPS, it is almost certainly having a deleterious effect on CAPS's star ratings of stocks. I don't know how much computing power this would require, but one could set up a "shadow CAPS" to track how the stock ratings would go in the absence of 3x ETF's (not calculating them into the points, accuracy, and therefore rankings of players) and track how that affects what is 5 stars, or how the performance of each star category of stocks performs. 

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#10) On September 14, 2011 at 7:14 PM, truthisntstupid (79.66) wrote:

"...almost certainly having a deleterious effect on CAPS's star rating of stocks..."

That was my complaint, too.

Here we go...again?

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#11) On September 14, 2011 at 8:02 PM, XMFCrocoStimpy (97.52) wrote:

#9 - Flea, we have developed a system called the Wabac machine (thank you Dr. Peabody and his boy Sherman) that does exactly what you propose.  In fact, that is how we do our historical testing of different metrics, algorithms, etc: we program the new rules and then re-run CAPS history through the new system.  This isn't able to capture how players would change their strategy due to the different rule structure, but at least it tells us how a proposed change would impact the system as it has been used.

#10 - truth, not starting again, just continuing :)  It is difficult to come up with straightforward conclusions, and every test seemingly spawns a half dozen more that need to be done, so change comes slowly.  Rest assured (if you are looking for assurance) that I spend a large portion of my time wrestling with these and similar problems in an effort to improve the CAPS system.

Fool On,


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#12) On September 14, 2011 at 8:06 PM, truthisntstupid (79.66) wrote:

Hi Xander!

I just thought FB might be interested in reading the thread I linked to in which you have already given lengthy answers to the same questions he's asking.

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#13) On September 14, 2011 at 9:09 PM, SultanOfSwing (32.40) wrote:

For those of you against playing leveraged ETFs on CAPS, I'm wondering if you're only against players like UltraSuck who red-thumb them forever (to prove a point about volatility decay), or also against players like etftimedecay (and me), who tend to use them to improve their market top and bottom calling.  These are two completely different strategies and the latter is no easy task.

Incidentally, I'm edging into small caps for Swing Trading, so my % use of ETFs should go down over time.

Garbage can charm?  Hmm.  I guess I'll have to change my CAPS name to OscarTheGrouch.


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#14) On September 14, 2011 at 9:47 PM, FleaBagger (27.52) wrote:

Yes, truthisnt, this is a lot like what you were saying, but at least those All Stars are losing points when they hold those red thumbs on DRI as it doubles. If they weren't awesome at something else in the game, they would have a negligible effect on a stock's rating. My complaint is that they have a bigger effect on it than they would if they couldn't exploit time decay in 3x ETF pairs.

Sultan - If you are actually green-thumbing 3x's in market timing, kudos to you! I haven't looked at your scorecard, and I notice that you are absent from the top 20 underperform players.

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#15) On December 07, 2011 at 11:25 PM, d1david (28.44) wrote:

Easy solution... just elimanate the shorting ability on them.  If one wants the leveraged points,  if bullish can green thumb FAS, or if bearish green thumb FAZ....  if someone green thumbs these firebombs... they better know what they are doing...

so only green thumbs allowed on 2x and 3x etfs.. simple as that


I agree, the false ratings jumps from all the red thumbing of these pairs influences the caps rating on the other "real" stocks/etfs that they rate

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