Why So Many Investors Want These Big Losers to Recover

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

After having set new records throughout much of the past few months, the S&P 500 took a break from its bull-market rally over the past week, falling just over 2%. Even though the stock market has repeatedly managed to bounce back from minor dips to push ever higher, many investors are making big bets on increased levels of volatility in the market -- and the huge losses they've suffered so far still hasn't made them lose their resolve.

Why volatility trackers have been losers this year
The losses that investments linked to volatility have suffered have been truly massive. The volatility-tracking iPath S&P 500 VIX Short-Term Futures ETN has lost more than 50% of its value so far this year, while the leveraged VelocityShares Daily 2x VIX ST ETN has plunged more than 80%. Yet even as these investments have seen their share prices fall, investor interest has remained strong, with the iPath ETN having pulled in more than $850 million during just the first five months of the year.


The reason is simple: choppiness in the stock market simply hasn't led to sustained periods of heightened investor anxiety. Even during the months of May and June, when a big jump in interest rates led some to believe that the Fed's imminent exit from its quantitative easing policies could lead to a sustained market correction, modest losses in major-market stock benchmarks were quickly followed by pushes to new highs. As the market continued to dodge potentially catastrophic events, volatility levels fell, causing losses for ETN holders.

The appeal of volatility
So why do investors continue to gravitate toward volatility-linked products? There are likely two reasons, with each appealing to a completely different set of investors.

On one hand, volatility-linked investments act like an insurance policy against heightened volatility. So even if they tend to lose value during calm periods, some investors are comfortable with those losses as long as they feel certain that they'll earn big gains from volatility ETNs if the market crashes and sends the rest of their stock portfolios falling.

On the other hand, some speculators see volatility ETNs as a lottery ticket. Sure, you'll suffer complete losses for a long time when no crash happens -- but when it does come, you hope that the payoff will make up for all the losses you've suffered along the way.

It's obviously impossible to know who'll end up on the right side of that debate. But one thing is clear: the only investors winning the volatility bet are those choosing the inverse side of the trade, with the VelocityShares Dailiy Inverse VIX ETN posting gains of more than 60% this year. As long as there's no big market decline, that trading pattern is likely to remain intact.

Don't let market volatility keep you on the sidelines. Millions of Americans have missed out on huge gains and put their financial futures in jeopardy. But it's not too late to turn things around, as we want to give you our brand-new special report, "Your Essential Guide to Start Investing Today." Inside, The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

The article Why So Many Investors Want These Big Losers to Recover originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter: @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Gumby

There is so much intricateness in the daily trading at Wall Street. I amdoing my best to explain what trading actually means and what you can do to protect yourselves from the ugliness out there at Wall Street! Read below!~

August 19 2013 at 5:05 PM Report abuse rate up rate down Reply
Gumby

If any stock is traded mostly in cash accounts, then it is stronger in price than stocks that is traded heavily in margin accounts which mean a lot of borrowed money is ridden on the stock prce itself. Margin accounts is what short sellers is really after because short sellers are allowed to borrow shares from margin accounts held by unwitted shareholders who seek to boost returns but are very vulnerable to short sellers that way. Many shareholders know that and they probably know exactly when to get out before short sellers jump in . or that those shareholders on margin accounts probably also morph themselves into short sellers themselves and give other shareholders also on margin accounts really nasty whiplashes! Brokers are also allowed to borrow shares from any of your margin accounts for short for their own accounts as well. There is of course regulations but what many shareholders probably dont know is that their shares in margin accounts are not supposed to be bought and held longterm... Margin accounts charge high interest rates and it is not wise to buy and hold stock on margin.. Get in and out with as much gain as you can get away with.

August 19 2013 at 5:00 PM Report abuse rate up rate down Reply