The stock market is made up of many different securities, ranging from company stocks and shares, to indices, bonds, currencies, commodities, and digital assets. Retail investors trying to invest into the right securities face a daunting task sorting the wheat from the chaff.
Thankfully, instead of attempting to pick individual stocks and shares to place their bets on, investors can make use of exchange-traded funds (ETFs) to gain broader market exposure, reduce risk, and even potentially benefit from both bull and bear markets.
In this article, we will be taking a look at what ETFs are, types of ETFs available, and how you can trade them.
What are ETFs?
An ETF is a type of investment security that is composed of a basket of securities. Virtually any type of security can be chosen when structuring an ETF, which has given rise to ETFs structured along different asset classes, geographical regions and even investing styles.
While there are myriad ETFs available to investors and traders in the market, they all share some common features.
Typically, ETFs are designed to track the price movements of their underlying basket of stocks, bonds, currencies, commodities or markets.
Another commonality is that all ETFs can be traded on an exchange, just like you can with company stocks. This means that ETFs are traded several times throughout the trading day, and prices go up and down as they are bought and sold.
ETFs are a popular investment product – in 2021, total investment in ETFs reached USD 9.94 trillion worldwide .
Types and categories of ETFs
An equities ETF is composed of several different company stocks or shares (equities), and are among the most common types of ETFs.
Within the universe of equities ETFs exist several sub-groups. These are organised along different characteristics, such as sector, market capitalisation or inclusion in benchmark indices.
An ETF that tracks the prices of bonds (a type of fixed-income security). Bond ETFs may be structured around corporate, government, municipal, international or global debt. Some may also focus on a certain range of maturity dates.
These types of ETFs pay out interest through periodic dividend payments. If there are any capital gains, they are paid out annually.
ETFs can also be structured along sectors, comprising companies that operate within a particular niche or sector. Some examples are technology, consumer goods, energy, pharmaceutical, manufacturing, banking, etc.
These are ETFs that track the prices of a selection of commodities, such as metals and ores, grains, livestock, lumber, crude oil and other raw materials or agricultural products.
ETFs that offer exposure to foreign exchange or currencies.
Currency ETFs can track the price of single currencies or a collection of different currencies.
ETFs that focus on securities in a country or geographical region. These can range from ETFs based around mature economies to ones that track emerging markets.
There are also ETFs for new or alternative markets, such as blockchain and crypto.
Blockchain ETFs focus on companies working on blockchain technology, which is the technology that underpins cryptocurrency.
Meanwhile, cryptocurrency ETFs track the prices of cryptocurrencies such as Bitcoin and Ethereum, allowing exposure to price movements without having to own cryptocurrency.
Why trade ETFs?
One compelling reason to trade ETFs is that they are a way to achieve diversification in your portfolio, which lowers the risk of being overly exposed to any particular sector or market.
Additionally, buying a single ETF can provide exposure to several different securities at once, without the need to pick, purchase and track individual stocks, bonds or commodities.
Low investing capital
Not only do ETFs allow investors and traders to gain exposure to securities without having to take direct ownership, they also lower the barrier to entry.
For example, trying to own every stock of the top 500 technology companies in the world is probably too costly for the average retail investor. Instead, you can simply buy shares of an S&P 500 ETF to gain exposure to the same collection of companies, with a much lower capital.
Another advantage of ETFs is that there is no minimum investment amount required. Investors are free to invest any amount they wish, and even beginners can easily start investing with just a small budget.
Just like stocks and shares, ETFs are traded on stock exchanges several times a day.
As such ETFs are highly liquid and traders can buy or sell their positions at any time. This high degree of liquidity makes them suitable for traders who aim to take advantage of short-term market opportunities.
However, do note that ETFs that are less frequently traded may be more difficult to sell off.
Typically, ETFs are designed to follow the price movements of their underlying securities or assets, and once created, do not require the active involvement of a fund manager.
As such, most ETFs are a type of passively managed investment funds, and therefore, come with lower fees compared to an actively managed fund.
Having said that, note that ETFs are still subject to commission fees, although not all online brokers collect them.
Additionally, there are some ETFs that are actively managed; an investment or fund manager oversees the portfolio and makes changes to the holdings with the aim of garnering better returns. These types of ETFs have a higher fee than passively managed ones.
How to trade ETFs?
ETFs may be traded via an online brokerage that offers them.
Simply sign up for an account to start buying and selling ETFs – you’ll likely find a substantial list of the most popular ETFs available at leading brokerages.
Because ETFs are so versatile, they are well-suited to a range of investing and trading strategies, ranging from long-term strategies such as capital appreciation and passive income, to short-term plays such as day or swing trading.
Furthermore, because they are traded like stocks, investors can use a variety of order types (e.g., limit orders or stop-loss orders) for finer control.
ETFs can also cater to more experienced traders pursuing advanced strategies through the financial derivatives, such as Contracts-for-Difference (CFDs) to speculate on the price movements of the underlying ETF. This allows investors to go long or short on various market conditions.
CFDs for ETFs can also be traded on leverage with relatively small starting capital, but please be aware that doing so will amplify any gains or losses.
The actual trading strategies to employ will depend on your individual goal, timeline and preferences, but given the sheer variety and range available, the chances of finding suitable ETFs are high.
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- “Exchange-Traded Fund (ETF) Explanation With Pros and Cons – Investopedia” https://www.investopedia.com/terms/e/etf.asp Accessed 12 May 2023