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The big ol’ world of investing can feel overwhelming to navigate. There are stocks, bonds, commodities, mutual funds, and exchange-traded funds, to name a few.

With so many choices, it can be hard to nail down just where to start.

The confusion is especially real for investors who are just getting into the game, whether it’s because they are young, earning more for the first time, or are finally ready to invest after paying down student loans.

One investment type that has gained in popularity with all types of investors, both new and seasoned, is the exchange-traded fund. This investment type is more commonly referred to by its acronym, “ETF.”

How do ETFs work? An ETF is an investment fund that you can buy and sell like a stock, but that potentially bundles together some other investment types, such as bonds.

In this way, they are similar to mutual funds, though ETFs are structured to give them some tactical advantages over mutual funds.

To understand the benefits of the ETF, it helps to first know what an ETF is and how ETFs work. With some ETF basics down, you can decide whether it’s the right choice for your investment portfolio.

What is an ETF?

An ETF is an investment fund that pools together different assets, such as stocks, bonds, commodities, or currencies, and then divides its ownership up into shares.

This means that with just a few clicks, it is possible to buy one fund that provides exposure to hundreds or thousands of investment securities. ETFs are often heralded for helping investors gain diversified exposure to the market for a relatively low cost.

This is important to understand—the ETF is simply the suitcase that packs investments together. When you invest in an ETF, you are exposed to the underlying investment. For example, if you are invested in a stock ETF, you are invested in stocks. If you are invested in a bond ETF, you are invested in bonds.

ETFs were created to try and improve upon the mutual fund. Unlike a mutual fund, which only trades once a day, an ETF is structured so that it trades like a stock, on an exchange (such as the New York Stock Exchange), during normal market hours.

While the market is open, it is possible to buy or sell an ETF nearly instantaneously—and see an ETF’s value in real-time. A mutual fund only provides its value at the end of the trading day.

Most ETFs track a particular index that measures some segment of the market. For example, there are multiple ETFs that track the S&P 500 index. The S&P 500 index is a measure of the stock performance of 500 leading companies in the United States.

Therefore, if you were to purchase one share of an S&P 500 index fund, you would be invested in all 500 companies in that index, in their proportional weights.

This means that most ETFs are passive, which means to track an index. Again, their aim is to provide an investor exposure to some particular segment of the market in an attempt to return the average for that market. If there’s a type of investment that you want broad, diversified exposure to, there’s probably an ETF for it.

Though less popular, there are also actively-managed ETFs, where there’s a person or group that is making decisions about what securities to buy and sell within the fund. Generally, these will charge a higher fee than index ETFs, which are simply designed to track an index or segment of the market.

How Do ETFs Work?

To answer the question, “How do ETFs work?” it helps to start by thinking about how a mutual fund works, because mutual funds are slightly more intuitive.

Investors in mutual funds buy their shares from, and sell their shares to, the mutual funds themselves. Mutual funds price their shares each business day, usually after the trading day is closed.

To calculate the value of one share, the fund first calculates its total assets (minus its liabilities) to obtain the Net Asset Value (NAV) of its holdings. Then, the NAV is divided by the total number of shareholders.

Because ETFs trade on a continual basis, this pricing methodology wouldn’t be fast enough. ETF sponsors need to create and redeem shares throughout the day. Therefore, ETFs require market arbitrage to keep their prices accurate. How exactly does that work? Let’s take a look.

First, remember that an ETF trades like a stock. For this to happen, ETF sponsors generally have a relationships with one or more “authorized participants”—typically large broker-dealers. Generally, ETFs only work with authorized participants to purchase and redeem shares.

They are able to make fast exchanges with ETF sponsors when they need either large blocks of the underlying securities, called “creation blocks,” or when they are attempting to trade out the ETF fund shares themselves.

But this is only part of the story. ETF prices are constantly fluctuating with the buying and selling of that ETF. That’s the power of supply and demand at work.

Meanwhile, the same thing is happening with the underlying stocks held within the fund. Because of this, the price (also known as the market value) of the ETF can deviate from the price of its underlying assets (the Net Asset Value, or NAV).

This creates an opportunity for arbitrage, where a trader could potentially take advantage of the discrepancy between the NAV and the market value.

When these traders act in a way to take advantage of the discrepancy, it helps to close the gap, and push the two values closer. By publishing the NAV and allowing traders to act on the information, the market price of an ETF often stays near that of the NAV.

Benefits of Using ETFs

ETFs are gaining popularity as a tool for short and long-term investors alike—they make it easy to get started. Some investors may opt to take the DIY approach, and others will prefer to have someone help manage their ETF strategy. Either way, ETFs offer some benefits to the investors that choose to use them.

Tax Benefits

ETFs are often considered more tax efficient than a mutual fund. When shares of a mutual fund are redeemed, it is possible that capital gains taxes are passed through to investors.

Because ETFs generally “redeem” shares through an in-kind trade with an active participant, minimal capital gains taxes are triggered. ETFs typically pass through less capital gains costs than comparable mutual funds.

Talk to a tax professional to learn more about the potential tax benefits of an ETF.

Low-Cost

ETFs and mutual funds charge what is called an “expense ratio,” which is an annual fee charged for upkeep in the fund. While both index mutual funds and ETFs are considered cost-effective ways to invest in the market, ETFs usually eke out some costs savings over index mutual funds.

Expense ratios aren’t the only fees charged by both ETFs and mutual funds, though. Because an ETF trades like a stock, there is often a transaction/trading fee to buy in and out of the fund.

Some mutual funds may have front-end load fees or back-end load fees that work in a similar manner, though you’d generally only see these fees on actively-managed mutual funds. Either way, make sure that you are looking at all of the fees involved in buying or selling any investment, not just the expense ratio.

Easy Diversification

Ever heard of the investing adage, “don’t put all your eggs in one basket?” That’s the idea behind diversifying your investments. Owning just one bond or one stock, or even a handful of bonds or stocks, can be considered risky.

By owning hundreds of investments all within one single investment, you minimize the risk of any one investment (such as a stock) doing poorly and tanking your portfolio along with it.

For example, if you were to buy an S&P 500 index ETF, you’re not just investing in one fund, but you’re investing in the 500 leading companies in the United States, achieving near-instant diversification. And by using an ETF, you get access to this diversification at a fairly low cost.

Investing in ETFs

There is no one way to use ETFs to invest. Some investors may be interested in the short-term moves of the market and use ETFs to place bets for or against those moves. Other investors may use ETFs to achieve broad, cheap exposure to the market in a long-term, buy-and-hold strategy.

For those interested in the latter, long-term strategy—which is likely most people—it is possible to buy a portfolio of ETFs through your brokerage firm of choice. This strategy will require you to choose investments that match up with your long-term goals and risk tolerance.

Investors who are interested in utilizing an ETF strategy but aren’t interested in the DIY approach may prefer to have the help of a professional.

Not only can the right professional help guide you into the right portfolio strategy for you, but they are there to help you manage your ETF strategy over the long-term. A professional can help you rebalance your portfolio and manage your investments from a tax standpoint.

If you want to invest in low-cost, diversified ETFs and have the support of investment professionals, check out SoFi Invest®.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Advisory services are offered through SoFi Wealth LLC, an SEC-registered investment adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at adviserinfo.sec.gov .

SOIN19045

When you think of trends, you might think of that time when everyone thought trucker hats were really cool, or how right now it seems like you can’t throw a rock without hitting a poke bowl spot.

And while a trend can be a current style or preference, the word can also mean a line of development or a more general shift in direction.

When it comes to trend-trading strategies to buy and sell stocks, these latter meanings are what traders are concerned with.

Here’s a look at what trend trading is and some common strategies with which it is associated.

What Is Trend Trading?

Trend trading, also called trend following, is essentially an offshoot of technical analysis—a set of strategies used by traders to examine stock prices over time, identifying patterns to help them know when it is potentially a good time to buy or sell.

To use the aforementioned trucker hat as an analogy for a moment: You basically want to start wearing those hats before they are cool and ditch them before the trend has played out.

Trend traders are often trying to make a similar move, buying stocks when they’re cheap, before there’s too much demand, then selling before the stocks are expensive and the trend is about to end.

Trend-trading strategies attempt to identify whether stock prices are moving up or down, and how fast—then using that information to decide when to buy and sell stock positions.

When prices move in one of these directions it can represent a trend. Generally there is an assumption that prices will continue to move in one direction unless acted upon by an event or outside influence.

Think of it a bit like the laws of inertia in physics. In physical science, an object in motion or at rest will stay in motion or at rest unless acted upon by an outside force. The same applies in trend trading, and when an outside force causes a change in a stock, this moment is called a pivot.

Traders will use a number of strategies to try to take advantage of trends and pivots. For example, if a trader believes that a stock price is on a downward trend, they might take a short position, selling stock and potentially rebuying later at a lower price.

On the other hand, if a trader believes that a stock is on an upward trend, they might take a long position. In other words, they would buy stock under the assumption that it will increase in value over the long haul and that they’ll be able to sell it at a higher price.

A Closer Look at the Types of Trends

While rising and falling trends are perhaps the most obvious and spottable types of trends, there is also a third, or neutral trend. If you were to look at a chart of stock prices, a neutral trend would basically be a flat, or horizontal, line.

You might also notice that asset prices during rising and falling trends tend to move in waves. For example, a stock price during a rising trend might rise a little, then make a brief dip before rising again, and so on. The inverse would be true for falling trends.

The end of a rising wave is known as a local, or swing, high. The end of a falling wave is a local, or swing, low. Traders will often zero in on these moments, using them to their advantage, helping them make buy or sell decisions, or using them as key data points for other types of analysis.

Trends can extend over short or long periods of time. Traders may look at months- or days-long trends, or they may zoom in and look for opportunities in hour-by-hour trends.

Rising Trends

You might hear rising trends described as “bullish” for the way they are moving forward. Generally, during these periods, there is relatively low volatility and low trading volume. These periods are characterized by short pullbacks on stock price, which are also known as countertrends. In general, however, the rising trend is a series of higher swing lows and higher swing highs.

Because of their low volatility, rising trends may be relatively easy for the average investor to trade in. That said, the countertrends tend to be short and shallow, which can mean it’s not always easy to know when to jump on board.

Falling Trends

Falling, or “bearish” trends are characterized by a series of lower swing lows and lower swing highs. In other words the wave pattern starts to reverse itself. The falling trend markedly differs from a rising trend because there is more volatility, and highs and lows are quick to follow each other.

Falling trends can be tricky for the average investor to negotiate due to their inherent volatility. Price movements and countertrends can be big, which can make them exciting to investors, but can also make it difficult to profit off the trend.

Neutral Trends

Neutral trends tend to represent a break between rising or falling trends during which stock price moves up and down in small increments during an extended period of time. This occurs as the price bounces back and forth between what is known as levels of support and resistance.

Think of it a bit like ping-ponging between the floor and ceiling of supply and demand. At this point the price is moving “sideways,” and if you plot the trend lines they will look horizontal and flat.

Trend-Trading Strategies and Indicators

Here are a few of the most common trend-trading factors, strategies, and indicators that help traders take advantage of trends:

Stop-Loss Order

A stop-loss order is a tool investors use to help manage the risk that prices will fall. They work when you place a stop-loss order with a stockbroker, who will then automatically sell a stock when its price falls to a certain predetermined level.

For example, say you bought a stock during an uptrend at a swing low. You might then set a stop-loss order at that price—your purchase price—in case the stock price begins to fall. (A stop-loss order may execute at a price lower than the purchase price, even if it is set at the purchase price, so it is not a guarantee against losses.)

For longer-term trend trading, investors may set the stop-loss order further away from the purchase price to allow for some of the natural ups and downs that can occur during an uptrend.

Stop-loss orders help investors lower their risk by hedging against decreases in the prices of their holdings.

Reading Trend Lines

Traders use trend lines plotted against a stock price chart as a sort of map to help them know when to make trades. Trend lines either connect swing lows or swing highs. The lines connecting swing lows represent uptrends, and the lines connecting swing highs represent downtrends.

As we’ve already mentioned, there can also be neutral trend lines that move sideways.

A typical chart might have multiple trend lines plotted against it, which can help traders identify opportunities to buy and sell. For example, there might be a long ascending trend line representing an upward trend in stock price.

A trader may look for short downward trends over the same period, and the points at which those short trend lines meet the long upward line could represent opportunities to buy.

The opposite may also be true—during a long downward trend, short upward trends may provide an opportunity to sell the stock position.

Trend lines are dynamic and frequently need adjusting. That’s because stock prices don’t move in a predictable fashion.

It’s important for investors to keep in mind that stock prices may move up and down away from the trend line and that doesn’t necessarily mean that the trend has ended.

Sometimes, traders may draw a trend line that represents a line of “best fit,” which can keep them from having to adjust too frequently when new data points fall outside previous trend lines.

Because trend lines can be imprecise, it may make sense for investors to think of them more as a guide than as a hard and fast indicator of when to buy and sell.

Momentum Indicators

One of the most important factors traders often try to identify within a trend is how strong the trend is, which helps them answer the question: is it likely to continue? This factor is known as momentum.

Momentum indicators compare a recent closing price with a closing price from the past. The time span between the two closing prices can be any length, and the momentum indicator can be calculated using one of two methods.

The first way to calculate momentum is simply by taking the difference between the current closing price and the closing price from a previous period. When the resulting number is positive the current closing price is higher than the previous price, and when it’s negative the current closing price is lower.

How far the difference is above or below zero is the indicator of how fast the price is moving. So a difference of 0.75 represents greater upward momentum than a difference of 0.45.

The second way to calculate momentum gives you a rate of change. You divide current closing price by past closing price and multiply by 100. When the resulting percentage is above 100, currently closing price is higher than past closing price, and when it’s below 100, the current closing price is lower. How far above or below 100 is the indicator of momentum. A rate of 90%, for example, is falling faster than a rate of 95%.

Increasing or decreasing momentum can provide buy or sell signals to investors. When looking at a momentum chart, these signals may occur when the momentum line crosses above or below the zero line. Momentum can also be used to help validate trades based on other price movements.

Moving Averages

When you look at a stock price chart it can be a bit messy, and the jagged lines can be hard to read. A moving average provides a way to organize that data more smoothly by taking the average of past closing prices over a given period of time. This much simpler line can help investors spot trends more easily.

When a stock price is above its moving average, it can indicate upward trends. When it’s below the moving average, it can indicate downward movements.

Investors may encounter two different types of moving averages: simple moving averages (SMAs) and exponential moving averages (EMAs). SMAs are the basic average of closing prices, whereas EMAs give more weight to more recent closing prices and adapt more quickly to recent price changes.

Neither method is necessarily better than the other, though depending on the other strategies you’re using, one may work better.

When You’re Ready to Buy or Sell

Which strategy you use when buying stocks or other securities ultimately depends on your own situation. If you’re a hands-on investor, trend trading is a strategy that might help you identify individual stocks. Other investors may be interested in a more hands-off approach, buying mutual funds or index funds that already hold large baskets of stocks.

Once trend traders have identified a stock to buy or sell and the moment to do so, they can execute a trade inside a brokerage account by placing an order with a stockbroker. This is also the time when investors would place a stop-loss order on a stock if they wish to use one.

Trend trading is markedly different from the long-term investment strategies that many investors use. For example, some investors use a goals-based investing strategy in which an investor is saving for long-term goals, such as retirement; others might use a buy-and-hold strategy.

These strategies hold investments for long periods, theoretically allowing them to grow and ride out any short-term market volatility.

When trend traders add any individual stock to a portfolio, they should be sure that it aligns with their long-term goals, their asset allocation, and diversification plans.

Whether you’re looking to be a hands-on or hands-off investor, SoFi Invest® has a platform for you. Active investing lets you buy and sell your own stocks — with zero SoFi transaction fees (subject to change).

If you don’t have time for making charts and tracking trend lines, automated investing may be the right fit for you. (SoFi does not offer stop-loss orders, but investors can place limit orders. There is a difference between these order types and investors should do additional research before placing a limit order on the SoFi platform.)

SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.


SOIN19179

When it comes to investing, there’s an old adage, “Don’t put all your eggs in one basket.” (Who carries their eggs in a basket anymore?) This is generally referred to as portfolio diversification.

The idea does make sense. Buying only one or two similar stocks might feel risky (and may be risky), no matter how profitable the companies currently are.

But did you know that diversification goes beyond the stock portfolio? For many investors, diversification might mean investing in other asset classes that don’t perform like stocks.

In fact, instead of considering which stock to buy, it may be more important to decide if it’s appropriate to own stocks in the first place. And, if it is appropriate, an investor may also want to ask: what proportion of a portfolio should be stocks?

Another way to describe the mix of stocks, bonds, cash, and other asset types in a portfolio? Asset allocation, or quite literally, the amount of money that is allocated to each of the different asset classes.

So what is asset allocation? Although it sounds like investing jargon, asset allocation is one of the more important investing concepts to understand. And although there is not a universal consensus about the right allocation mix for each investor, this big-picture decision could drive a majority of returns over time.

What Does Asset Allocation Mean?

Asset allocation is the investment strategy of balancing risk and reward by divvying up a portfolio into different asset types.

Generally, asset allocation is determined by looking at goals, risk tolerance, the investing timeline for the investor’s money, and comparing that to what the different asset classes have done over history. That way, an investor can determine what mix of assets is a good fit for what an investor is trying to accomplish.

Each asset class will have its own path of performance over time. The goal of diversification is to invest in such a way that not all investments perform the same or even similarly during different periods over the course of an investment journey.

For example, some investors may find it helpful to make investments beyond stocks during a stock market crash, which could have a sweeping and dramatic impact on all stock prices. Historically, bonds have performed well during stock market crashes, and aren’t considered to be correlated to stock market prices.

Therefore, bonds can act as a portfolio hedge during those stock market downturns. Another way to think about diversification? Stocks zig while bonds zag—or at least they have historically.

Using Modern Portfolio Theory

For all the statistics buffs out there, it may help to think of asset allocation in terms of Modern Portfolio Theory (MPT) . MPT assumes that investors are risk averse, and builds portfolios with the lowest level of risk given the desired level of return.

It does this by analyzing the historical return of each asset class, the variability of that return (called the variance), and the degree to which the price level of different asset classes experiences volatility at the same time (the correlation).

Within portfolios, volatility and risk are often measured by their standard deviation (which happens to be the square root of the variance).

For example, if there were two portfolios and both have the same expected rate of return, but one has a lower standard deviation, the investor may want to choose that one.

Managing Risk by Asset Class

Whether the goal is to try to minimize risk, maximize potential returns, or some combination of the two, a good place for an investor to start is to study the risk and return characteristics of the various asset classes, such as stocks, bonds, cash or money market funds, real estate, private equity, investment partnerships, and natural resources, like gold. Much of the time, the discussion about risk and reward of the different asset classes is focused only on the tradeoff between stocks and bonds.

Common stocks, also known as equities, historically fall on the higher risk and higher reward end of the spectrum. Bonds are often considered to be lower in risk but also lower in reward.

Cash and cash equivalents (like money market funds) are typically considered to be the safest options, in the sense that cash experiences little price volatility. But be aware: The value of cash is eroded by inflation over time, which means potentially losing purchasing power.

Not all stocks or bonds are the same. Categories within each of the asset classes may carry different risk and reward characteristics. For example, small cap stocks are typically considered to be riskier but may come with higher returns than large cap stocks (also known as big cap stocks), which are generally more established. This is because small cap stops have the ability to grow into large cap stocks, whereas large cap stocks may not experience as much volatility—in either direction.

That said, the difference between the two is somewhat subjective, and small cap stocks can be established (in other words, they’re not just start-ups), while large cap stocks can crash as well (think Enron). Within the category of bonds, for example, junk bonds may be riskier while U.S. Treasury bonds are considered a safer option.

Determining Asset Allocation

After learning what to expect from the different asset classes, a good next step is to think about goals, risk tolerance, and investing time horizon—for each pool of money to be invested. For example, an investor may want to invest retirement money differently than emergency money.

A couple questions an investor might begin by asking: What is their goal with this money? When will they need to use this money? The latter is the idea behind investing time horizon.

To determine an appropriate asset allocation, an investor may want to conceptualize how long this money needs to last or what amount is needed for a set goal. Last, they might consider asking: How much risk (volatility) are they comfortable with?

Recommended: age-based rule of thumb is to start with 100, subtract age, and the resulting number is the percentage to invest in stocks. (Or, simply invest current age in bonds, and the rest is allocated to the stock market.) So, for example, if someone is 30 years old, then this rule would have them invest in a portfolio of 70% stocks and 30% bonds.