Leveraged ETFs: How TQQQ, SOXL, and 3x Funds Work

What Are Leveraged ETFs? The Mechanics Explained

A leveraged ETF is a fund that borrows money or uses derivatives like swaps and options to amplify the daily movements of an underlying index or asset. Instead of moving 1% when the market moves 1%, a 3x leveraged ETF targets a 3% move—in the same direction.

The most popular leveraged ETFs track major indices:

• TQQQ — Aims for 3x the daily return of the Nasdaq-100 (tech-heavy index)
• QQQ (non-leveraged version) — Moves 1:1 with Nasdaq-100
• SOXL — Targets 3x daily returns of the Semiconductor Select Sector Index
• XLK (non-leveraged version) — Moves with the full Technology sector
• UPRO — Aims for 3x S&P 500 daily returns
• SPY (non-leveraged version) — Moves 1:1 with S&P 500

On a day when the Nasdaq-100 rises 2%, TQQQ should rise approximately 6%. When the Nasdaq-100 falls 2%, TQQQ should fall approximately 6%. This magnification happens through leverage—borrowing capital and using derivatives. The math is straightforward for individual days. The problem emerges over weeks, months, and years.

How Leveraged ETFs Actually Work: Daily Rebalancing

The Daily Reset Mechanism

Leveraged ETFs maintain their leverage ratio through a process called daily rebalancing. Each day, after markets close, the fund adjusts its position to ensure the leverage ratio resets exactly to 3x (or 2x, depending on the fund).

Here's why this matters: A 3x leveraged fund doesn't buy $3 worth of stock for every $1 in assets. Instead, it holds a basket of the index components (or futures) and uses borrowing or derivatives to achieve a 3:1 return multiplier—but only for that specific trading day.

At the market close, if the fund's leverage drift has shifted to 2.9x or 3.1x, the managers rebalance back to exactly 3x. This daily reset is critical to understanding volatility decay.

Example: A Single Day in TQQQ

Let's say you buy $10,000 of TQQQ on a morning when the Nasdaq-100 is at 16,000.

During that day, the Nasdaq-100 rises 2% to 16,320.

TQQQ should gain approximately 6% (3x × 2%), netting you a gain of about $600, bringing your position to $10,600.

At market close, the fund rebalances its derivative positions to ensure 3x leverage is reset for the next day. Your $10,600 position is now the new baseline for the next day's 3x multiplier.

This daily reset creates compounding—both for gains and losses. That's where problems arise.

The Volatility Decay Problem: Why Leveraged ETFs Lose Value Over Time

Understanding Volatility Decay

Volatility decay is the erosion of value in leveraged ETFs due to daily compounding in sideways or choppy markets. It's not a fee or market expense—it's a mathematical reality of how leverage works with daily rebalancing.

Here's the principle: A 20% loss followed by a 25% gain returns you to breakeven on a regular investment. But on a 3x leveraged fund, that same sequence leaves you significantly in the red.

Real Example: The 2022 Tech Crash

In 2022, the Nasdaq-100 experienced a severe bear market. Let's trace what happened to TQQQ holders:

January 2022: Nasdaq-100 at 15,265. TQQQ at approximately $80.

December 2022: Nasdaq-100 fell to 10,088—a 33.9% decline. You'd expect TQQQ to fall roughly 3x that: approximately 102% (wipeout). TQQQ actually closed around $8.48—a 89.4% loss.

Why didn't it lose exactly 102%? Because as the fund lost value violently, the daily rebalancing meant smaller dollar amounts were being rebalanced each day. But the principle holds: volatility decay ate away value.

Rebound in 2023: The Nasdaq-100 recovered 43% from its December 2022 lows by late 2023. If TQQQ had simply lost 3x that move, it would have gained 129%. Instead, TQQQ gained approximately 174%—better than 3x, because the math swings the other direction when markets move consistently in one direction.

The key takeaway: Leverage amplifies daily moves, but daily rebalancing causes compounding losses in volatile or sideways markets.

The Math Behind Volatility Decay

Here's a simplified breakdown. Assume a $10,000 position in a 3x leveraged fund tracking an index:

Notice: The index moved +2% overall, so 3x should yield +6%. You got +3.7%. The 2.3% difference is volatility decay—money lost purely to daily rebalancing chop in a choppy market. This gap widens with more volatility and longer holding periods.

Real-World Comparison: TQQQ vs. QQQ Over Different Time Periods

Let's compare the actual performance of TQQQ (3x leveraged Nasdaq-100) against QQQ (non-leveraged Nasdaq-100) from 2015 to 2024:

Observations:

• Over 10 years, TQQQ returned +600% vs. QQQ's +440%, but far below the theoretical +1,320% (3x). Decay consumed $720% of expected returns.
• In strong directional years (2020, 2023), leverage helped TQQQ outperform the 3x expectation slightly.
• In choppy/decline years (2022), TQQQ lost less than 3x due to the mechanics of rebalancing, but still suffered devastating losses.
• The compounding effect of daily rebalancing is brutal over long periods.

This is why financial advisors warn against buying TQQQ and holding it for retirement. A 10-year TQQQ holder would have been better served buying QQQ and holding it—or trading TQQQ for short periods only.

Different Types of Leveraged ETFs

2x Leveraged ETFs

2x funds amplify returns by 2 times the daily move. Examples include QLD (2x Nasdaq-100) and SAA (2x semiconductor). These decay slower than 3x funds because volatility impact is lower, but they still suffer from daily rebalancing drag in choppy markets. They're marginally more suitable for slightly longer holds (weeks rather than days) but still not buy-and-hold investments.

Inverse Leveraged ETFs (SQQQ, PSQ)

Inverse leveraged ETFs bet against their underlying index. SQQQ aims for 3x the inverse (opposite) daily return of the Nasdaq-100. When the Nasdaq-100 falls 2%, SQQQ should gain 6%. When it rises 2%, SQQQ should fall 6%.

These are even more dangerous for holding periods longer than days. They decay fastest in bull markets (which are far more common than bear markets historically). SQQQ holders who bought at the start of 2023 and held through the +43% Nasdaq rally would have seen massive losses despite being "protected" against downside.

Inverse leveraged ETFs are only useful for intraday or 1-2 day hedges, not multi-week positions.

Leveraged Commodity and Bond ETFs

Beyond equities, you'll find leveraged funds for commodities and bonds—like GUSH (3x crude oil) and TYD (3x 10-year Treasury duration). These carry the same volatility decay mechanics, plus additional complications:

• Oil: Contango and backwardation in futures markets add cost layers beyond daily rebalancing
• Bonds: Duration risk means a 1% rise in yields doesn't linearly translate to fund moves; leverage compounds this unpredictability

Most traders avoid commodity and bond leveraged ETFs for this reason.

When Leveraged ETFs Make Sense: Tactical Use Cases

Intraday Bets

If you believe the Nasdaq-100 will rise 3% today, buying $5,000 of TQQQ rather than $5,000 of QQQ gives you more exposure to that move. You capture gains without touching the fund overnight, sidestepping rebalancing drag. On a +3% day, TQQQ gains roughly 9% ($450), while QQQ gains 3% ($150). The leverage works in your favor because there's no compounding decay—just a single day's move.

Multi-Day Swing Trades

Some traders use leveraged ETFs for 3-to-10-day positions betting on a clear direction. During a strong rally or sell-off with minimal choppy reversals, leverage amplifies real gains. During the March 2023 regional banking crisis, traders who shorted the market via SQQQ for 3-5 days captured outsized profits. The key: The move was directional. There was no volatility decay because the market moved down consistently.

Hedging Short-Term Portfolio Risk

If you hold a $100,000 QQQ position and believe a sharp 1-week correction is coming, buying $20,000 of SQQQ provides insurance without selling QQQ (avoiding tax events and reentry risk). You'd expect to lose money on SQQQ if the Nasdaq rallies (the cost of insurance), but you'd also lose less on your QQQ position due to the hedge. This is expensive insurance—but sometimes worth it before major earnings or Fed announcements.

Not a Use Case: Long-Term Wealth Building

Despite marketing that positions leveraged ETFs as convenient trading vehicles, they are terrible for buy-and-hold investing. Someone who bought TQQQ in 2015 and held 9 years would have made +600% (decent), but the non-leveraged QQQ would have returned +440%—still excellent, with a fraction of the volatility risk and zero rebalancing decay.

Better approach: Buy QQQ or SPY for the long term. Use TQQQ, SOXL, or UPRO only for tactical positions you monitor daily or hold for specific market bets lasting days-to-weeks.

The Cost of Leverage: Fees and Interest

Expense Ratios

Leveraged ETFs charge higher expense ratios than their non-leveraged counterparts because they're actively rebalancing:

• QQQ (non-leveraged Nasdaq-100): 0.20% annual expense ratio
• TQQQ (3x leveraged Nasdaq-100): 0.95% annual expense ratio
• UPRO (3x leveraged S&P 500): 0.95% annual expense ratio
• SOXL (3x leveraged semiconductors): 1.08% annual expense ratio

The difference might seem small (0.75%), but compounded over years, it's material. On a $50,000 TQQQ position, you're paying $475 annually in fees vs. $100 for QQQ. That's $375 per year in additional costs—before volatility decay even enters the picture.

Borrowing Costs (Implicit)

Behind the scenes, leveraged ETF managers borrow money at current interest rates to maintain leverage. These borrowing costs are embedded in the fund's pricing—not shown as line items in your statement. In 2023, with federal funds rates at 5.25-5.50%, borrowing costs for leveraged ETFs rose. This widened the performance drag beyond the stated expense ratio.

Bid-Ask Spreads

Leveraged ETFs are less liquid than mainstream options like QQQ or SPY. The bid-ask spread—the difference between the price brokers will pay (bid) to buy your shares and the price they'll sell them to you (ask)—is wider. On a $10,000 TQQQ trade, you might lose $15-25 to spread costs. On a comparable $10,000 QQQ trade, you'd lose $5-10. These small costs compound across frequent rebalancing and exits.

Common Mistakes and Pitfalls to Avoid

Mistake #1: Holding Leveraged ETFs Through Market Gaps

Leveraged ETFs reset leverage at the close, not at the open. If the market gaps overnight (due to earnings, geopolitical events, or Fed announcements), your leverage resets at yesterday's close price, not today's open. This creates realized losses that don't get "reset" in your favor.

Example: You hold $10,000 in TQQQ. The Nasdaq-100 is expected to rise, so you hold overnight. During post-market trading, a major tech company reports terrible earnings. The Nasdaq-100 opens down 4% the next morning. Your TQQQ position loses roughly 12% overnight ($1,200). The leverage reset doesn't help—your new baseline is already $8,800. This is why leveraged ETF traders avoid holding overnight before major announcements.

Mistake #2: Buying Leveraged ETFs as a Long-Term Position

The historical data is unambiguous: Leveraged ETFs underperform their non-leveraged counterparts over multi-year periods due to volatility decay. If you believe in the Nasdaq-100 or S&P 500 for the next 10 years, buy QQQ or SPY. Using leverage amplifies short-term tactical moves—it doesn't improve buy-and-hold returns. It destroys them.

Mistake #3: Underestimating Tax Inefficiency

Leveraged ETFs rebalance daily. This rebalancing triggers capital gains within the fund, even if you haven't sold shares. These gains are distributed to shareholders, creating tax liability in taxable (non-retirement) accounts. For every dollar of gains TQQQ realizes, you owe taxes on 30-50% more than you'd owe on QQQ, because the daily rebalancing creates internal gains.

In a $50,000 TQQQ position that gains 20% in a taxable account, you might owe taxes on $12,000 in gains (from distribution) rather than the $10,000 you'd expect. The extra $2,000 comes from rebalancing-driven gains.

Solution: Only use leveraged ETFs in tax-advantaged accounts (401k, IRA) where daily rebalancing doesn't create immediate tax liability. Or accept that you're losing 5-10% of gains to taxes.

Mistake #4: Confusing 3x with 3 Times Safer

Some investors mistakenly think that because inverse leveraged ETFs (like SQQQ) amplify downside protection by 3x, they're three times safer than hedging with regular shorts or put options. They're not. Inverse leveraged ETFs decay fastest in bull markets. Holding SQQQ as a "long-term insurance" position is like paying for fire insurance on your house, then finding out the policy pays out three times as much during fire season—but only loses value the other 11 months.

Real protection comes from owning put options (with defined risk) or maintaining a diversified, rebalanced portfolio. Not from 3x inverse ETFs.

Mistake #5: Not Exiting on Win/Loss Targets

Successful leveraged ETF traders set price targets before entering. "I'm buying TQQQ here because I expect the Nasdaq-100 to rise 4-5% in the next three days. I'll exit at a 15% TQQQ gain or exit in three days—whichever comes first."

Without these guardrails, you're tempted to hold winners past their expiration date, exposing yourself to volatility decay and gap risk. You're also tempted to hold losers hoping for a bounce, digging yourself deeper.

Treat leveraged ETF positions like you would options: With entry prices, exit targets, and time limits.

Leveraged ETFs vs. Alternatives for Gaining Exposure

Leveraged ETFs vs. Buying on Margin

You could achieve 3x leverage by buying QQQ on margin (borrowing 66% of the position value). Margin interest rates are typically 6-9% annually. Leveraged ETFs embed this borrowing cost in their daily rebalancing and expense ratio (0.95%). If you're only holding for days, the expense ratio is better. If you're holding for months, margin might be cheaper. But margin also forces you to maintain minimum account balances and collateral—leveraged ETFs avoid this friction.

Leveraged ETFs vs. Options (Calls and Spreads)

Options provide defined risk. If you buy $10,000 of call options betting on a Nasdaq-100 rally, you lose at most $10,000 (your initial premium). Leveraged ETFs can theoretically decay to zero if volatility is extreme enough. Options also avoid daily rebalancing drag. But options have time decay (theta), expiring worthless if the market doesn't move fast enough. Leveraged ETFs don't expire.

For intraday trades: Options are better if volatility is expected to be low (theta won't hurt you). Leveraged ETFs are better if volatility is expected to be high (you avoid buying expensive premium).

For multi-day trades: Leveraged ETFs usually win because options lose value to theta.

Leveraged ETFs vs. Futures Contracts

Futures on the Nasdaq-100 (NQ) or S&P 500 (ES) provide true leverage without daily rebalancing decay. One contract of NQ gives you 100x the Nasdaq-100's daily move. You control the leverage ratio and only pay when you're using it. But futures require a margin account, active monitoring, and they expire (forcing you to roll positions).

Leveraged ETFs are better for retail traders who want leverage without the complexity of futures. Professionals prefer futures because they avoid rebalancing decay.

The Inverse Relationship: Why Leveraged ETFs Fall Fastest

This is a critical insight many traders miss: In declining markets, leveraged ETFs lose value faster than regular ETFs—not just 3x as fast, but significantly faster due to volatility spikes.

Here's why: Volatility typically rises when markets fall. When the Nasdaq-100 drops 2% on a calm day, TQQQ drops roughly 6%. But when the Nasdaq-100 drops 2% amid a panic spike, volatility can double the rebalancing costs, causing TQQQ to drop 8-10%. This is one reason bear market rallies often trigger losses in inverse leveraged positions (like SQQQ)—as fear subsides, the decay accelerates.

This is also why TQQQ was down 89% (not 99%) during the 2022 bear market. Yes, the index fell 33%, so 3x would be 99%. But as volatility spiked during the decline, the rebalancing mechanics slightly softened the blow. Counterintuitively, volatility helped leveraged ETF holders slightly during extreme declines.

Tax Considerations and Holding Periods

If you hold a leveraged ETF for more than one year, your gains qualify for long-term capital gains treatment (15-20% federal tax rates), which is better than short-term rates (ordinary income, up to 37%). However, the daily rebalancing generates short-term gains distributions within the fund itself, which are always taxed as short-term gains regardless of your holding period.

For example: You buy TQQQ in January and sell in March with a 20% gain. You pay short-term capital gains (37% federal top rate if applicable). But TQQQ also distributed $500 in gains from internal rebalancing. That $500 is also taxed as short-term gains. So you're paying short-term rates on both the realized gain and the unrealized internal gains.

This is why leveraged ETFs belong in tax-deferred accounts (401k, IRA, 403b) where daily distributions don't create tax liability until withdrawal. In taxable accounts, the tax drag is severe enough to make regular ETFs preferable for almost all holding periods longer than days.

Sector and Bond Leveraged ETFs: Special Considerations

Semiconductor Leverage (SOXL)

SOXL targets 3x daily returns of the Semiconductor Select Sector Index. Semiconductors are more volatile than the broader market, so SOXL's volatility decay is worse than TQQQ. A semiconductor rally can still see SOXL decay if it's choppy. However, the semiconductor sector has been in an uptrend since late 2023 (AI boom), meaning SOXL has outperformed expectations. This won't last once the sector becomes choppy or reverses.

Treasury Bond Leverage (TYD, PST)

Leveraged bond ETFs are particularly dangerous. Bond prices move inversely to interest rates, and rates are volatile. A leveraged 10-year Treasury ETF (TYD) rebalances daily while duration (interest rate risk) compounds. If rates spike 1%, a regular Treasury fund might fall 10%. A 3x leveraged version might fall 25-30%. The decay is brutal and less predictable than stock leverage because bond volatility behaves differently.

Few professional traders use leveraged bond ETFs. The risk/reward is asymmetrical.

How to Monitor a Leveraged ETF Position

If you've entered a leveraged ETF trade, here's how to actively manage it:

1. Set alert prices. Use your broker's alert function to notify you when TQQQ hits your profit target (say, +15%) or your stop loss (say, -10%). Don't check manually every hour—alerts eliminate emotion.
2. Monitor the underlying index. Watch the Nasdaq-100's daily moves. If it's up 2% and TQQQ is only up 5% (not 6%), volatility decay is already working against you. This signals choppy conditions where decay will accelerate.
3. Track calendar days. If you planned a 3-day trade and day 5 arrives with no move, exit. Leverage amplifies both gains and losses. Time decay isn't as brutal as with options, but it still erodes returns.
4. Avoid overnight holds unless essential. Even if you're early on your profit target, consider closing at the market close to avoid gap risk. The risk/reward of potential gains vs. overnight gap loss usually favors exiting.
5. Check upcoming events. Earnings announcements, Fed decisions, and economic data can gap the market. If you're holding TQQQ and major tech earnings are overnight, exit beforehand.

Practical Next Steps

If you're considering leveraged ETFs:

1. Start with a small position. Trade $1,000-5,000 in TQQQ or SOXL to feel the volatility. Don't commit significant capital until you've lived through a few gap days and rebalancing cycles.
2. Use them only for tactical bets lasting days to two weeks. Be specific about what move you're betting on and when you'll exit. Write it down before entering.
3. Keep them in tax-advantaged accounts if possible. The tax drag in regular brokerage accounts erodes returns significantly.
4. Understand your broker's rules. Some margin rules restrict leveraged ETF trading. Some brokers flag frequent leveraged ETF trades as pattern day trading. Confirm before you're in a position.
5. Stress-test against volatility. Imagine the market down 5% tomorrow. Can your portfolio handle a TQQQ position falling 15%? If no, position size is too large.

Summary: Leverage as a Tool, Not a Strategy

Leveraged ETFs like TQQQ, SOXL, and UPRO are powerful tools for short-term traders betting on specific directional moves. Over days to weeks, leverage amplifies real gains when the market cooperates. Over months and years, volatility decay erodes these funds until they underperform their non-leveraged counterparts significantly.

The key distinction: These funds are not investments. They're trading instruments. Buying TQQQ and holding it like a retirement position is like buying lottery tickets and expecting them to fund your future. It's possible you win big, but the odds—and the daily rebalancing math—work against you.

For buy-and-hold investors: Buy QQQ, SPY, or sector ETFs without leverage. Let time and compound growth work for you. For active traders: Use TQQQ and SOXL for specific 3-10 day bets when you see a clear market opportunity. Exit at your target or time limit. Treat them like options—tools with defined entry, exit, and risk parameters.

Leveraged ETFs work best when combined with discipline, position sizing, and a clear understanding that you're not riding them to retirement.

This article is part of Ticker Daily's complete ETF guide

Learn more about ETF investing in our hub article: How to Trade and Invest in ETFs: The Complete Guide. Explore related topics like ETF selection, sector rotation, and dividend investing strategies.