Contrary to expectations (including mine), the Direxion 300% leveraged and inverse ETFs are rapidly gaining traction in the marketplace.

The company launched eight super-leveraged ETFS earlier this week:

The funds are designed to deliver 300% and -300% of the daily return of their benchmark indexes, and follow in the success of the wildly successful ProShares ETFs, which provide 200% and -200% exposure to the market.

I must admit: I was very skeptical of these funds’ prospects at first. I worried that the funds were not appropriate for real “investors.” 300% is a lot of leverage, particularly when volatility is as high as it is today. Investors could easily lose half their money in a single day.

Moreover, I was concerned about the issue of compounding. I have written extensively about how compounding causes the long-term returns of leveraged funds to deviate from their expected goals. These ETFs are designed to deliver 300% or -300% of the daily returns of their benchmarks. Over a week, month or year, however, they won’t come close to that 300% return, because compounding (particularly in volatile markets) will have an enormous impact on the results.

I was also skeptical that these ETFs would attract much of a trading audience. The ProShares ETFs have enormous liquidity, which is one of the reasons they appeal to the trading community. I doubted that these ETFs could attract enough liquidity to convince the trading community to switch from the ProShares ETFs, despite the higher leverage rate offered by Direxion.

But since they launched on Wednesday, the Direxion ETFs have attracted significant trading volume and activity.

On its first day on the market, for instance, the Large Cap Bear 3x Shares (NYSEArca: BGZ) traded just 13,000 shares. On day 2, it traded 123,000 shares. Today, it traded 334,000 shares.

Its twin, the LargeCap Bull 3x Shares ETF (NYSEArca: BGU) has done even better, trading 19,000 shares, 361,000 shares and 581,500 shares, respectively.

That’s certainly not anywhere near what the ProShares funds trade. The ProShares Ultra S&P 500 (NYSEArca: SSO) traded 80 million shares today.

But hitting half a million shares traded on just the third day on the market is pretty darn good for an ETF. A lot of funds that I consider fairly liquid trade less than 500,000 shares per day, such as the Rydex S&P 500 Equal Weight ETF (NYSEArca: RSP) and the PowerShares Dynamic Market ETF (NYSEArca: PWC).

I still don’t think the Direxion ETFs make sense for investors, but it looks like the trading community might well embrace them.

Last 5 posts by Matt Hougan

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