During the six years I have been running my trading room, I have seen what traders do right and what traders do wrong. One of the biggest pitfalls I have seen that trip traders and investors up is the inappropriate use of leverage, writes Avi Gilburt of ElliottWaveTrader.net.

As some of you may know me by now, I run a trading room with over 3500 traders, have over 450 money manager clients, have over 23,000 followers on Seeking Alpha, and have the sixth largest service out of the 169 that are offered in the Seeking Alpha Marketplace (even though I am a technical analyst on that fundamental analysis website).

I have certainly come a long way since I first opened the doors to my trading room a little over six years ago.

As an investor or trader, you have a responsibility to yourself and your family to preserve your capital.  That means one needs to always maintain an appropriate risk management plan, which means you must know your entry, exit and stop-out level even before you enter a trade.  It also means avoiding the inappropriate use of leveraged instruments.  

Anyone with any experience understands that leverage is a double edge sword. When you know how to appropriately use leverage, it can turbo-charge returns.  But, when you do not, it can take you to the poor house. 

While most people are smart enough to stay away from options if they do not understand them, too many still use leveraged ETFs.  Most people also do not understand how these leveraged ETFs work.  And, that includes analysts.

Unfortunately, leveraged ETFs are designed in such a way that if you are not catching a strong trending move perfectly, you will lose money. Even if the market is moving sideways, these leveraged ETFs lose money.  

And, if the market moves down, well, you lose money twice or three times as fast. So, unless you are able to time the market absolutely perfectly, then you should never, ever, ever buy and hold one of these instruments. They are designed to be a trading vehicle and nothing more.

Yet, greed often gets the best of many investors, which makes these leveraged instruments look so enticing.  

Moreover, analysts who want to turbo-charge the returns they can publicize to bring in new subscribers will also gamble on the use of these leveraged instruments.  And, yes, I am using the word gamble appropriately in this instance, as that is what they are doing with your money when they tell you to buy-and-hold leveraged ETFs, while promising you the path to untold riches.

I have not yet seen a single instance where subscribers do not blow up their accounts when following an analyst who consistently advises a buy-and-hold strategy using these leveraged ETFs. I can assure you that those analysts care much more about their win rate than they do about your investment account.  

In fact, I have seen one analyst who has deleted their model portfolio many times when they have blown up due to inappropriately timed use of these leveraged ETFs.  In this way, he has been able to begin gambling with subscribers’ money all over again, so that he can advertise 500% returns in the last three months. Yet, he has blown up accounts each and every year for the last several years.

Real-life examples

Let me give you an example.  There was a “call” by an analyst I saw in 2016 which suggested to buy and hold a metals 3X ETF when it was around 25, without any stops, and using much more than 25% of your portfolio. In fact, this analyst did exactly what most amateurs do – they buy at just about the high of the market in an oversized position because they have been sucked in by the market sentiment. In other words, he was simply part of the herd being led to slaughter. And, he backed up his call by promising those who take his suggestion will be wealthy beyond their wildest imagination.

Sadly, for those investing their hard-earned money based upon that call, that 3X ETF hit a low of 3.77 only a few months later. For those counting, that is an 85% drop in price in a few months, and it was catastrophic to those who followed this call. 

Moreover, based upon the way these 3X ETFs are calculated, the underlying market will have to rally significantly higher than the point at which this investment was made in order for those who bought into this suggestion to even break even. 

Clearly, this analyst has not learned from his massive failures, as he has recently done it again to his subscribers. 

This time, he supposedly suggested a buy and hold on a 3X tech ProShares UltraPro QQQ  ETF (TQQQ) just as the market was hitting its highs.  And, again, he promised riches beyond their wildest imagination to those foolish enough to follow him. 

Unfortunately, these investors are now experiencing a whole lot of pain at this time.

So, please allow me to highlight some of the rules to which you always want to adhere in order to protect your capital over the long term, and avoid blowing up your account.

First, one should never buy a 3X ETF as an investment, as it is a trading vehicle and not a buy-and-hold vehicle. Any knowledgeable advisor or market analyst should know this, and if you see an advisor suggesting otherwise, please recognize that he is suggesting that you gamble with your money.

Second, any time you enter into trade or investment, you must know your entry, exit and stop out level before you even enter the trade or investment.  

Third, you should never place all your eggs or even the majority of your eggs in one basket. Personally, I suggest that investors not use more than 3%-5% of their account on any single product or stock.

Again, you have a responsibility to yourself, your future and your family’s future and should not be taking needless risks in an already difficult financial environment.

If you follow some simple risk management strategies and stay away from 3X ETFs for investment purposes, you give yourself a much better chance of finishing this marathon by avoiding any catastrophic set-backs, from which it could take years to recover. 

It does not seem as though regulators are protecting the public from analysts like the one noted above. That means it is incumbent on you to be responsible for your own trades and investments. 

And, if someone is suggesting overly aggressive positions utilizing leveraged products for a buy-and-hold scenario without any risk management plan in place, I would be running for the door as fast as I can. It is clear that this person does not have your best interest at heart.

Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net (www.elliottwavetrader.net), a live Trading Room featuring his intraday market analysis (including emini S&P 500, metals, oil, USD & VXX), interactive member-analyst forum, and detailed library of Elliott Wave education.