Russell 2000 Bears Should Take Profits

On Oct. 1, I mentioned the ProShares UltraShort Russell 2000 (TWM - commentary - Trade Now), the double inverse of the index tracked by iShares Russell 2000 Index (IWM - commentary - Trade Now), as a good candidate for the bears. The Russell 2000 is much weaker than the S&P 500 Index on down days and it hasn't recovered on the up days.

From the close of Oct. 1 to the close of Oct. 27, the Russell 2000 Index gained 0.6% compared to 3.3% for the S&P 500 Index. IWM gained 0.6% over that period, while TWM lost 2.5%. As I've repeatedly warned investors, the leveraged ETFs have compounding error, and it's fully on display, with TWM down 4 times as much as IWM gained. Direxion Daily Small Cap Bear 3X (TZA - commentary - Trade Now) fell 4.1% over the same period, or nearly 7 times the underlying index. (Both turned profitable for the month in midday trading today.)

However, ProShares UltraShort S&P 500 (SDS - commentary - Trade Now) lost 6.9% over the same period. This confirms that the Russell 2000 was the better index for the bear traders, in addition to some individual sectors that have lagged the market, and I believe it will continue to be moving forward.

On Oct. 22 after the close, I commented on how the Dick Bove situation revealed further short-term market weakness when his call on Wells Fargo (WFC - commentary - Trade Now) led to a market-wide selloff, and I mentioned TWM as a way to play it. Since then, TWM went on to gain 8.6%.

Traders should take their gains here, ahead of the GDP number tomorrow. If the numbers are weak, it will cost you to miss the initial move, but there will be time to profit. On the other hand, a strong number could send the market higher after several straight days of losses, and it's those volatile days moving against your position that kill holders of leveraged ETFs.

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At the time of publication, Dion had no positions in the stocks mentioned.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.