What Are ETFs?
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This article will provide professional traders with an explanation of what ETFs are, what ETFs are in stocks, and what ETF trading is. This article will also explore the appeal of ETFs to individual investors, the disadvantages of ETFs, and a description of leveraged ETFs
What Is An ETF?
An Exchange traded fund (ETF) is a group of securities that you can buy or sell via a brokerage company on a stock exchange. ETFs can offer a range of asset classes – from traditional listed company investments to other asset streams like currencies or commodities. Furthermore, ETF structures enable investors to short markets, gain leverage, and avoid short-term capital gains taxes in some jurisdictions.
Exchange-traded funds are one of the most sought-after financial products for small investors recently created. ETFs offer a broad array of benefits and, if selected carefully, can be an excellent mode for achieving investment goals. As a product, ETF began in 1993, and its underlying form was a broadly known ticker symbol SPY, or Spiders.
It went on to become the highest-volume ETF in history. On US stock exchanges alone, there are nearly 1,000 ETF products with around $1 trillion invested in total. Admiral Markets offers the ability to trade on thousands of stocks and ETFs, and over 300 ETF CFDs.
What Is ETF Trading?
Just like company shares listed on an exchange, an ETF can be bought and sold during the stock exchange open hours. Also, like listed stocks, an ETF will have a ticker symbol with an intraday price. Where it differs to company stocks is that the number of shares available in an ETF can change daily as a result of continuous creation of new shares, and redemption of existing shares.
The market price of an ETF is usually kept in line with the underlying securities on an ongoing basis, based on the ability of an ETF to issue and redeem shares within itself. As ETFs were created for individual investors, institutional investors still maintain the liquidity and tracking integrity of ETFs by purchasing and selling units.
As the price of an ETF deviates from its underlying asset value, the institutions use an arbitrage system by creating units to bring the ETF price in line with its underlying asset value. Generally, ETFs are outstanding investment choices. They can be bought and sold in real time, just like stocks, and have lower management fees. ETFs are also starting to replace mutual funds as the chosen investment.
The Appeal Of ETFs To Individual Investors
- Tax efficiency: Investors can have better control over when they pay capital gains tax.
- Lower fees: As there may not be any sales load, however, brokerage commissions will apply.
- Sell and buy during any time of day: Mutual funds can settle after the market close.
- Trading transactions: As ETFs can be traded like stocks, investors can place a variety different orders (limit orders, stop-loss orders, buy-on-margin orders, etc.) which are not available with mutual funds.
- Lower risk: Additionally, there is arguably lower investment risk, known as beta risk, or investment risk which is spread over some underlying assets, rather than an individual company.
Disadvantages Of ETFs
While they have many advantages in many fields, ETFs do have some drawbacks, including:
- Settlement delays: ETF sales may not settle for two days after a transaction, which implies that the seller's funds may not technically be available for re-investment until the two days have passed.
- Illiquidity: Some thinly traded ETFs may have wide bid/ask spreads, meaning your transaction costs could be high, although the same can be said about small company stocks that are thinly traded.
- Arbitrage discrepancies: While ETF prices track their underlying asset class reasonably well, there can be discrepancies.
- Trading costs: If the investment value is small or less frequent, there could be lower-cost alternatives by investing directly in the asset class.
What Is A Leveraged ETF?
According to Investopedia, the basic definition for 'Leveraged ETF' is a fund that uses financial derivatives and debt to amplify the returns of an underlying index. These funds aim to keep a constant amount of leverage during the investment time frame, such as a 2:1 or 3:1 ratio. Leveraged ETFs use financial derivatives and debt instruments to consistently amplify the returns of an underlying index.
Don't forget that some leveraged ETFs can produce unintended results if you hold them too long. Due to the mathematical nature of these funds, the long-term performance won't necessarily match the index it tracks — especially those that are designed to act inverse to the equity index. When you start ETF trading, try to keep your losses small in each trade that you make. It is perfectly normal to make mistakes, as even the best professional traders make mistakes from time to time.
But keep your losses under control, that is of utmost importance. The majority of successful ETF traders have strong mental discipline to do their best, and to leave their large winners to run, while never letting their losses surpass a set threshold of 5%-10%, especially if the markets are choppy. ETF trading systems and ETF swing trading strategies do exist.
Retail traders and investors usually use different strategies, such as:
- Asset allocation
- Dollar cost averaging
Invest With Admiral Markets
Before you start trading, it's essential that you choose a reliable ETF broker for ETF trading, for example, Admiral Markets is an award winning, regulated broker that offers the Admiral.Invest trading account for traders. If you want to trade on 15 of the world's largest stock exchanges, with access to FREE real-time market data, advanced chart and technical analysis, a state-of-the-art trading platform and more, click on the banner below to open your account today!
This material does not contain, and should not be construed as containing, investment advice or an investment recommendation or, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not reliable indicator for any current or future performance as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisor to ensure you understand the risks.