Understanding Leverage Decay
Why leveraged ETFs lose value over time, even when you're right about direction
Critical Concept
Leverage decay is the single most important concept to understand before trading leveraged or inverse ETFs. Ignoring it can lead to significant unexpected losses.
What is Leverage Decay?
Leverage decay (also called "volatility decay" or "beta slippage") is the erosion of value that occurs in leveraged ETFs due to daily rebalancing. These products are designed to deliver their target multiple (2x, 3x, -1x, -2x, -3x) on a daily basis only.
Over periods longer than one day, the compounding of daily returns causes the ETF's performance to diverge from the simple multiple of the underlying index's return.
A Simple Example
Imagine an index starts at 100 and a 2x leveraged ETF starts at 100:
Day 1: Index drops 10% (100 → 90)
2x ETF drops 20% (100 → 80)
Day 2: Index rises 11.11% (90 → 100) — back to starting point!
2x ETF rises 22.22% (80 → 97.78)
Result: Index is flat (0% return), but 2x ETF lost 2.22%
This happens because the ETF rebalances daily. After Day 1, it has less capital to work with, so even though it gained 22.22% on Day 2, it couldn't fully recover.
Why Volatility Makes It Worse
The more volatile the underlying index, the worse the decay. In choppy, sideways markets, leveraged ETFs can lose significant value even if the index ends up flat.
This is why leveraged ETFs are designed for short-term trading only — ideally single-day holds.
Key Takeaways
- Leveraged ETFs deliver their target multiple on a daily basis only
- Over longer periods, returns will differ from the expected multiple
- High volatility accelerates decay
- Even being "right" about direction doesn't guarantee profits over time
- These are trading instruments, not investments