An ETF is the Exchange-Traded Fund which means it holds various underlying assets such as, for example, stocks, currencies or commodities. This is the main difference between ETFs and regular stock. You can buy or sell ETFs on a stock exchange. What are the types of ETFs and how to trade them? Let’s see into this topic.
Contents
ETFs’ basics
An exchange-traded fund consists of a whole basket of securities. Its price changes many times during the day because it can be, unlike mutual funds, traded all day on a stock exchange. It may attract traders thanks to low expense ratios and fewer broker commissions in comparison to when you buy stocks individually. ETFs are characterised by higher liquidity than mutual funds.
ETFs are a good option if you think about diversification of the assets because there are already multiple instruments within one ETF. These instruments can be related to many industries or one sector only. Some are international, others available only for the USA.
Some examples of ETFs are the SPDR S&P 500 (SPY), the Invesco QQQ (QQQ) or the iShares Russel 2000 (IWM).
What are the types of ETFs?
- Industry ETFs focus on a specific industry. It might be banking, oil and gas sector or technology.
- Bond ETFs invest in government bonds, state, corporate or local (municipal) bonds.
- Currency ETFs include foreign currencies.
- Commodity ETFs invest in commodities, crude oil and gold, among others.
- Inverse ETFs are base on the shorting stocks which means a stock is sold, its value is expected to fall and then it is bought at a lower price. Be careful as some inverse ETFs can turn out to be ETNs (exchange-traded notes) that are traded like a stock.
Buying and selling ETFs
Buying and selling ETFsIt is possible to trade ETFs with traditional broker-dealers and online brokers as well. Check if your broker has ETFs in its offer.
ETFs pros and cons
The first advantage of trading ETFs is that you get access to various stocks from many industries. And for a relatively low price as you make one transaction instead of multiple ones. This means fewer broker commissions.
Another good thing is that risk is well managed because of diversification provided by ETFs. On the other hand, if you are interested in investments in a particular sector, you can choose an ETF that focuses on that industry. Remember though it will reduce diversification.
Typically, ETFs track an index and this makes operational costs low. This is called ETF’s expense ratio.
On the downside, the fees for actively managed ETFs are quite high. Actively managed ETFs require more involvement in purchasing and selling shares and making changes in the fund’s holdings. This results in a higher expense ratio.
Be aware of the low-volume ETFs. Exchange-traded funds have gained large popularity and so new funds have risen. Some may feature low trading volume.
What are creation and redemption in respect of ETFs
Creation and redemption regulate the supply of ETF shares.
Creation
This is a name for the process of increasing the number of ETF shares. This process consists of selling stocks to the ETF sponsor by an AP (authorized participant) in exchange for an ETF shareholding.
Redemption
This is a process of reducing the number of ETF shares. An AP purchases the ETF shares on the open market. Then sells them to the ETF sponsor in return for individual stock shares which can sell on the open market later on.
Summary
ETFs are financial instruments that allow relatively easy investments in the group of assets. An individual investor does not need to analyse each and every one instrument from the group. It is enough to decide if a given sector will rise or fall. It is much easier and more convenient than analysing multiple stocks, commodities, or bonds.
For instance, if a trader thinks that the marijuana market will expand more then, rather than analysing all marijuana companies, he can buy marijuana ETF shares such as CNBS (Amplify Seymour Cannabis ETF) or THCX (Cannabis ETF).
Share your experience in trading ETFs in the comments section below.
Wish you successful trading!