Condor Options

One of the trading myths we noted recently has generated some questions.  There seem to be some passionate proponents of applying technical analysis to leveraged ETF charts out there, and while that notion has already been debunked elsewhere, we thought we’d take a different approach, just for fun.

Here’s an argument in favor of technical analysis based on support and resistance.  Define “support and resistance” however you wish, as long as the definition has to do with price behavior driven by buyers and sellers.

1. In the past, trading a set of rules, r, based on areas of support and resistance has been profitable.
2. Given (1), if a daily price chart for a given asset displays areas of support and resistance, then I should trade the asset using r.
3. The daily price chart before me displays areas of support and resistance.
/4. Therefore, I should trade this asset using r.

This is all stipulative, and it doesn’t matter whether any of the premises are actually true for the purposes of this post.  But we take this to be an argument that any proponent of technical analysis would assent to.  If we grant the premises, then any trader with access to a chart and r is justified in trading the asset on the screen.

However, premise 3 will never be true of any of the leveraged ETFs, because the changes in price aren’t driven purely or even primarily by supply and demand – they’re driven by changes in some other underlying asset.  The leveraged ETFs are only designed to mimic the daily performance of their underlyings, which means they will not have (and have not had to date) a 1:1 correlation with the underlying over any period longer than a day.  So trading them using r isn’t justified, at least not by the argument above.

Note that all of this is entirely consistent with the possibility of someone trading leveraged ETFs using r successfully.  But if they did so, their success would be caused by something other than (1), which means that until someone develops an explanation for why trading leveraged ETFs using support and resistance is profitable, it doesn’t seem justified to do so.  Alternatively, someone could demonstrate that trading leveraged ETFs technically has been historically profitable without any explanation, but for such a claim to be robust, one would need a longer trading history than is possible at this time given how new most of these products are.