I field a lot of great questions from the contact form located under the Resources tab on the top menu of the site and from time to time, I like to share some of those questions & my reply as it might benefit other traders. In fact, I’ve spent most of my day working on upgrades to the site that will soon allow for the addition of a comments section below each post. Not only will that allow for posting of questions & comments about a trade or market development, which others can view, but it will also allow for the sharing of other pertinent information on each particular trade such as an upcoming scheduled earnings release, breaking news, or links to additional commentary/analysis on that trade idea.
With that being said, here’s a question & reply to the current ERX short trade:
Q: Instead of shorting ERX could I buy ERY?
A: Sure but ERY is best used for very short-term trades, usually measured in hours to just a few days at most. If the crude oil & the energy stocks play out as I’m expecting, they are likely to pull back from at or near current levels (I could see the possibility of one last thrust to a marginal new high), energy stocks are likely to move lower for at least several weeks, maybe even a couple of months or more.
I’m not sure if it will be a relative deep correction (assuming that I’m right on the pullback call) but at the very least, they look poised to consolidate while chopping around in a trading range for a while. Unlike its non-leveraged counterpart, XLE, if the energy sector were to chop around in a sideways trading range for several weeks or more, going basically nowhere, ERY (or ERX for that matter) would drop considerably in value due to the decay suffered by leverage etfs.
More on that can be found here: http://rightsideofthechart.com/faq/disadvantage-leveraged-etf-long-term-decay/ (end reply)
To add to my reply, I should have also stated that as shorting ERX is not an option for all accounts, for example IRA’s, which do not allow shorting, or even some marginable brokerage accounts, whereby the broker does not have any shares of ERX available for their customers to short. Therefore, here are a couple other alternative to shorting the energy sector via ETFs.
DDG is the ProShares Short Oil & Gas ETF (non-leveraged or 1x short). As DDG is not leveraged, if the energy sector trades sideways for while, DDG would basically just be a dead-money trade (no losses, no gains).
DUG is the ProShares UltraShort Oil & Gas ETF (2x leverage short). DUG might be a viable alternative for a short on the energy sector lasting a week or two & would suffer minimal decay should we get a relatively straight move down towards the 18.05 area on XLE as I expect. To be clear, a “relatively straight” move down does not mean that XLE will go down each & every day until I reaches that support area, simply that the counter-trend bounces will be relatively minor & few compared with the amount of down days in XLE until we get there.
My current expectation is that XLE will move down to the 18ish area within two weeks although being short ERX (assuming that I am not stopped out), if it takes much longer to do so, that time & choppy price action will work in my favor. Remember, the greater the leverage (2x vs. 3x) and the more times that the leveraged ETF closes red for the day, the larger the decay on that ETF will be.