Why Leveraged ETFs Like TQQQ Can Be Risky After a Major Market Rally

In the wake of a major market rally, investors often find themselves seduced by the allure of amplified returns. Leveraged ETFs like ProShares UltraPro QQQ (TQQQ), which triples the daily performance of the NASDAQ-100, have become a go-to tool for those seeking to capitalize on momentum. But as history shows, holding these instruments for the long term can be a perilous game—one where volatility decay and compounding risks erode gains faster than most realize.

The Allure and the Trap of TQQQ

TQQQ's performance from 2020 to 2023 was nothing short of electrifying. In 2020, it surged 110.05%, riding the tailwinds of the pandemic-driven tech boom. By 2023, it had added another 198.04%, cementing its reputation as a rocket ship for growth. Yet, these gains came with a hidden cost: volatility. Leveraged ETFs are designed for short-term bets, not long-term holds. Their daily compounding mechanism works wonders in rising markets but backfires spectacularly during corrections.

Take 2022, for example. As the Fed aggressively hiked rates to combat inflation, TQQQ cratered. Its worst drawdown hit -81.66% by December 2022, a gut-punch for investors who had grown complacent after years of gains. Recovery took 486 trading days—a stark reminder that leveraged ETFs can turn euphoria into despair in a heartbeat.

Recency Bias and the Illusion of Invincibility

After a prolonged rally, recency bias kicks in. Investors begin to believe the good times are here to stay, ignoring the cyclical nature of markets. This mindset is particularly dangerous with leveraged products. TQQQ's 2020-2023 run created a false narrative: that tech stocks—and by extension, triple-leveraged bets on them—were immune to downturns.

But 2022 shattered that illusion. As interest rates rose, the magic of compounding worked in reverse. TQQQ's 3x leverage magnified not just gains but also losses, leading to a vicious spiral. The lesson? A leveraged ETF's performance is not a straight line—it's a rollercoaster with a steep drop waiting to derail the unwary.

Diversification: The Antidote to Volatility Decay

This is where diversification becomes critical. Enter TMF, the Direxion Daily 20-Year Treasury Bull 3X Shares. Historically, TMF has served as a hedge against equity downturns. During the 2000 dot-com crash and the 2008 financial crisis, long-term Treasuries rallied as investors fled equities, providing a buffer for portfolios. A 60/40 split between TQQQ and TMF, for instance, historically reduced drawdowns by balancing aggressive growth with defensive fixed income.

However, 2022 exposed a flaw in this strategy. Rising rates crushed long-term bonds, dragging TMF down -92.61% for the year. The negative correlation between stocks and bonds, a bedrock of diversification, broke down. TQQQ and TMF moved in lockstep, offering no refuge. This underscores a hard truth: no single hedge is foolproof in all market environments.

Strategic Hedging in a Shifting Landscape

So, what's the solution? A balanced approach. While TMF can still play a role, investors must recognize its limitations in a high-rate world. Alternative hedges—such as inflation-linked bonds (TIPS), gold, or even sector-specific ETFs—can add layers of protection. Rebalancing quarterly or semi-annually ensures your portfolio adapts to changing conditions.

Consider this: during 2022, a 60/40 TQQQ/TMF portfolio still lost -75.47%, far worse than the -32.75% drop in TQQQ alone. That's because TMF's losses amplified the pain. A diversified approach—mixing TMF with other uncorrelated assets—could have softened the blow.

Discipline Over Complacency

The key takeaway? Leverage is a double-edged sword. It magnifies gains in up markets but inflicts catastrophic losses in downturns. After a major rally, the temptation to "double down" with a 3x ETF is strong. But history shows that complacency is the enemy of long-term sustainability.

For those who insist on using TQQQ, treat it as a tactical tool, not a permanent holding. Pair it with hedges like TMF, but don't rely solely on them. Monitor macroeconomic shifts—interest rates, inflation, geopolitical risks—and adjust your allocations accordingly.

Final Thoughts

Leveraged ETFs like TQQQ are not inherently bad—they're powerful instruments when used wisely. But they demand discipline, a clear exit strategy, and a willingness to adapt. In a world where market regimes shift rapidly, the old rules of diversification are evolving. The lesson from 2022 is clear: no asset, no matter how "safe" it seems, is immune to volatility.

For investors seeking long-term sustainability, the path forward lies in balance. Embrace the upside of growth while guarding against the downside with a mosaic of hedges. In the high-stakes game of leveraged investing, caution and adaptability are your best allies.