How To Trade ETFs: Diversify Simply And Inexpensively

June 12, 2020
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ETFs are financial instruments that will allow you to invest in a wide variety of assets because they replicate indexes of countries, regions, sectors, bonds, among many others. In this way, knowing how to trade ETFs will allow you to diversify your investment portfolio. Throughout this article, you will see the main points that you should know before choosing an ETF as an investment instrument. If you are an investor that uses ETFs or you are thinking of investing your capital in these types of instruments, the best thing for you is to complement your strategies with expert financial advisory services.

In this way, you will be able to make better decisions, choose the best balance between risk and capital, and structure profitable investment plans. We recommend Capitalist Exploits financial services because it will allow you to have a broader view of the market. In fact, Capitalist Exploits provides information and analysis into investment opportunities that have the potential to provide impressive gains without taking on additional risk.

#1 What Is An ETF

Before you see how to trade ETFs, you need to know that ETF is the abbreviation for Exchange-Traded Funds and consists of a financial instrument that allows you to invest in a wide variety of assets in a simple and economic way. In a nutshell, an ETF is a publicly-traded investment fund.

When you buy an ETF you are acquiring a set of assets that replicate a particular index whether it be from a country, region, sector, bonds, equities and even real estate indices. You can compare ETFs to any market including major ones like the New York Stock Exchange or Nasdaq Stock Market.

Furthermore, you will know what to expect from the ETF result because, in theory, the ETF should match the evolution of the index it replicates. For example, in the following chart, you will see how the growth of Standard & Poor’s 500 (red line) and an ETF that replicates it (blue line) have a very similar evolution.

Standard & Poor's 500

1.1 An ETF Allows You To Diversify Your Investment Portfolio

Please note that an ETF allows you to diversify your investment portfolio. Diversification is very important when investing in the stock market because you can mitigate risk and at the same time keep the performance of your investments stable. The fundamental principle of diversification is not to invest all your capital in a single asset, i.e. don’t put your eggs in one basket. When you buy an ETF you are buying many assets in one package.

An ETF is a vehicle that allows you to diversify in a big way without needing hundreds of thousands of dollars to do it. For example, imagine that you want to replicate the Standard & Poor’s 500 Index (one of the most important stock indices in the United States) on your own because you believe that the market as a whole will have a good streak, that is, you expect the S&P 500 to grow.

Ok, the first thing you have to do is find out how the S&P 500 Index is built. In the following image, you will have an initial idea of where to start.

how the S&P 500 index is built

Then you must determine how many shares of each company you must buy to replicate it exactly. Most likely, at the end of the tour, you have spent time and money because you will have to pay each buy commission for each number of shares of each company you buy.

If you buy an S&P 500 ETF, you will not spend time or money on commissions and that’s it. You already diversified! Also, an S&P 500 ETF is much more affordable.

1.2 Differences Between ETFs And Investment Funds

An investment fund seeks to raise capital from different types of investors, natural or legal persons, with the aim of investing the capital raised in different financial instruments. For their part, ETFs can be bought or sold as if they were shares on the stock market.

Investment funds can be active or passive investment while ETFs are passive management. Take into account that an active investment is about your own capital management. It is a strategy with which you create your own strategies and an investment plan. In the case of ETFs, investment is passive because these types of financial instruments simply replicate an index.

The goal of investment funds is to be more profitable than indices. For their part, ETFs want their profitability to coincide with that of some market index. This feature will allow you to have a clear idea of the results that you will have with your ETF. You just have to see if the index that it replicates rises or falls.

#2 How To Buy ETFs

ETFs are traded on the stock exchange in the same way that shares are bought or sold. ETFs are traded daily and can be traded at any time during each session. You only need to generate a buy or sale order in your broker. We have talked about platforms where it is possible to trade this type of financial instrument.

We recommend our articles “eToro Review: Multi-Asset Social Trading And CopyTrading Platform” and “Robinhood Review: Operate In The Market Without Commission”. There, you will see how to use investment platforms to trade financial instruments such as ETFs. You will also find some interesting tips that can help you when devising investment strategies. Below we will show you the evolution of the main ETFs in the market.

How To Trade ETFs: Main Types

There are a lot of ETFs on the stock market. You will see as many ETFs as indices and even more:

Stock Exchange ETFs: When you buy this type of ETFs you will be buying a fund that replicates the evolution of some index that is built by stocks. Each ETF of this type will allow you to diversify your investment because they simulate the evolution of the market. For example, the Dow Jones, Nasdaq or S&P indices.

Industry Sector ETFs

In this case, the ETF simulates the evolution of indices for specific sectors such as technology, energy, real estate, software & services or banking. These types of funds are very popular because they will allow you to invest in specific areas in which you want to invest to complement your investments.

Commodity ETFs

With this type of ETF, you can buy a whole range of supplies. Take into account that commodities are important because they represent the input to produce other goods. For example:

  • Energy: Like oil, coal or natural gas.
  • Metals: Could be precious metals like gold or industrial metals like copper or nickel.
  • Agricultural: There is an extensive variety such as wheat, rice, soybeans or corn.

Currency ETF

With these ETFs, you can get a basket of currencies buying a single instrument. With these types of instruments, you can make investments in Forex without the need to waste time and money. It is important to take into account that the currency market is very speculative, which makes it risky.

International ETF

Thanks to these financial instruments you will be able to diversify your portfolio on an international scale because they are made up of stocks from other countries. This type of investment will help you mitigate, for example, political risks because your investment covers several regions.

#3 How To Buy Oil ETFs

To trade Oil ETFs, just like in the case of company stocks, you need to look for the ETF ticker. The ticker of a stock or any ETF is a product identifier that is a little more summarized than its original name. For example, below we will show you some of the most outstanding ETFs in the market, in each chart, you will find the evolution of the ETF (black line) and the trading volume (green and red bars):

a.-ETF Name: United States Oil Fund_Ticker: USO

How To Trade ETFs: Oil ETFs

b.-ETF Name: United States 12 Month Oil Fund_Ticker: USL

How To Trade ETFs: Oil ETFs

c.-ETF Name: ProShares Ultra Bloomberg Crude Oil_Ticker: UCO

How To Trade ETFs: Oil ETFs

Once you have found the ETF you want to invest in, the next step is to create a buy or sell order in your broker. Later we will talk about the most recommended strategies to trade with ETFs. In any case, take into account that you should not buy an ETF lightly or because everyone is talking about its evolution, you should always do an analysis to make the best decision. Take into consideration that you should complement your investment ideas with the recommendations of a qualified advisor. Indeed, we suggest our post “Capitalist Exploits: A Measured Approach To Achieving Asymmetric Returns”, where you’ll learn a lot more about investing and get great recommendations. In it, we cover the type of content and services Capitalist Exploits offers, how it works and in which markets they recommend you invest in.

#4 How To Trade Leveraged ETFs

Leveraged ETFs are synthetic financial instruments. That is, it does not entail the buy of shares or other financial instruments such as ETFs. The goal of Leveraged ETFs is to multiply the result of any index by a factor. For example, the S&P500 2x ETF will double the result of the S&P500 index. If the S&P500 rises 20% then the S&P500 2x ETF will generate a result of 40%.

However, you must be very careful when using Leveraged ETFs because in the event that you have two times your capital there could be two scenarios. In the first scenario, you would double your profit because you would get double your capital. But, in the second scenario, you could lose double your investment.

Below you will see an example of how volatile these types of instruments can be. In the chart, you will see the evolution of a Nasdaq 100 ETF and a 3x Leveraged ETF-Nasdaq 100.  The Nasdaq 100 is a stock market index that includes the 100 most outstanding companies in the technology sector.

You will see that the evolution of the 3x Leveraged ETF-Nasdaq 100 (green line) is volatile compared to the Nasdaq 100 ETF (blue line). This makes Leveraged ETFs financial assets that are used more in day trading strategies because in the long term it is more difficult to predict their evolution. In the following section, you will see the main strategies for trading ETFs.

How To Trade ETFs: Leveraged ETFs

#5 How To Trade ETFs: Strategies

ETFs are great for diversifying your portfolio. Also, the fact that they can be traded as shares gives you the opportunity to use short and long-term investment strategies; everything will depend on the type of ETF you want to buy.

For example, if you think that the economy is going to grow and that the market is in a growth phase, the ideal decision is that you buy ETFs of some index that replicates the market, and keep it until you think that the trend could change. Also, keep in mind that the best strategy to invest in Leveraged ETFs is short-term investments due to their high volatility.

5.1 Some Of The Most Used Strategies

Asset Allocation

The first step that must be taken to use this strategy is to define the level of risk and the time horizon of the investment. Once these factors are determined, the next step is to choose the assets. Then, it is necessary to determine the proportion of each asset that you want to combine taking into account the level of risk that you are willing to tolerate. Finally, you must adapt the combination of your portfolio as time goes by. Take into account that the younger we are, we could take a greater amount of risk because we will have time to recover capital in an unfavourable event.

Trend Trading

Investors try to make a profit by studying the direction of prices. If the trend is bullish (there is a maximum price), investors will take a long position and buy the asset. If the trend is bearish (there is a minimum), investors will take a short position by selling.

Swing Trading

It consists of taking advantage of short-term price patterns. While trend-based investors seek to take advantage of the direction the market is taking in the long term, swing investors are often more interested in small reversals in the price movement of a market, and try to detect these reversals in advance and operate in order to profit from small swings.

Scalping

The strategy is to carry out a large number of operations that remain open for a very short time. It is a short-term trading strategy that allows you to obtain small but frequent profits, since it focuses on achieving a high rate of profit. Scalping requires a very strict exit strategy, since losses can quickly offset benefits.

Sector Rotation

Using ETFs you can apply the Sector Rotation strategy because there are ETFs by sector or industry. The strategy aims to change your investments as the business cycle changes. In this way, you can take advantage of the growth of specific sectors throughout the year.

5.2 How To Trade ETFs: Trading Plan

The ideal when devising investment strategies is that you focus on a trading plan that allows you to achieve your goals. To devise your trading plan you must take into account the following factors:

  • Objective: requires defining goals, capital, risk, schedules, and markets.
  • Analysis Method: it is important to choose the analysis method, type of charts and indicators.
  • Systematic Review Of The Plan: it allows detecting errors and improving the strategy.

We recommend you read our article “How To Start Day Trading: Generate Returns During The Same Day“, there you will find short-term strategies, indicator analysis, the best way to create a trading plan and many more tips that will allow you to increase your skills as an investor.

We recommend that you complement your trading plan with the advice of investment experts. If you want a newsletter that is really focused on expert investment analysis and also has a format that allows you to quickly access relevant information, we recommend Insider Weekly, one of the Capitalist Exploits services created for people who need a business advisor and who also have a very complete agenda. This is a weekly newsletter at a very affordable price.

#6 How To Trade ETFs: Pros And Cons

Pros

  • They allow you to diversify because you will have access to a large number of assets.
  • You save time and money. It is much more expensive to replicate a stock index on our own.
  • It is possible to know the price of each ETF in real-time.
  • ETFs are transparent in relation to the instruments that compose it.
  • It is possible to sell and buy ETFs at any time of the session.

Cons

  • There is a risk associated with ETFs. For example, if you buy an ETF, your loss is tied to the drop in the index that the ETF is replicating.
  • Investment knowledge is required to invest in ETFs. In fact, ETFs are considered complex financial instruments.
  • ETFs that focus on specific sectors or industries limits diversification.
  • Leveraged ETFs are very volatile. This aspect makes them risky.

How To Trade ETFs In A Nutshell

ETF is the abbreviation for Exchange-Traded Funds and consists of a financial instrument that allows you to invest in a wide variety of assets in a simple and economic way. Also, When you buy an ETF you are acquiring a set of assets that replicate a particular index, whether it is from a country, region, sector, bonds, equities and even real estate indices.

Take into account that an ETF will allow you to diversify your investment portfolio. Diversification is very important when investing in the stock market because you can mitigate risk and at the same time keep the performance of your investments stable. In any case, we recommend that you look for investment experts who will give you the best advice so that you can maximize your profits.

We recommend a reputable and reliable investment advisor. If you are just starting out in the investment world, or are already a professional, but don’t want to be exposed to high risks, we recommend that you join Capitalist Exploits today for three reasons:

  • The first is that Capitalist Exploits provide an incredible amount of information about financial markets that help beginners learn.
  • The second is that Capitalist Exploits is focused on identifying high-return, low-risk investment opportunities, which is exactly what someone who is just starting out on business needs.
  • Finally, the level of diversification offered by Capitalist Exploits will allow you to create more efficient portfolios to achieve your goals.