Conventional wisdom suggests investors are limited in what they can do with an exchange-traded fund (ETF). An investor can certainly buy into a fund based on portfolio needs and unique investment preference, with the goal hanging on to a good ETF for the long haul. That’s called taking a “buy and hold” strategy, which is common with mutual funds and ETFs.
But ETFs offer investors more options than that. For instance, it’s possible to trade an ETF, too, just like one would a stock, commodity, or cryptocurrency.
Let’s take a closer look at trading ETFs, and dig into the components, strategies, and trading formulas that can work with a fund.
An exchange-traded fund is a popular investment vehicle that enables investors to buy a group of stocks in one bundle, thus promoting investment diversity and efficiency. They’re widely available, usually through major investment fund companies.
ETFs aren’t mutual funds, although they originate from the same fund investment family. The primary differences between the two is that mutual funds are usually more expensive than exchange traded funds. Another benefit of ETFs is that whereas mutual funds can only be traded after the end of the market day, ETFs can be traded during open market sessions at any point in the day.
ETFs have become wildly popular: According to the Investment Company Institute, the combined assets of the nation’s exchange-traded funds totaled $6.49 trillion in June, 2021.
Different Types of ETFs
ETFs are represented in all of the main stock categories, as follows:
• Stock ETFs: This type of ETF is composed of various equity (stock) investments.
• Bond ETFs: Bond funds hold different types of bond vehicles, like U.S. Treasury bonds, utility bonds, and municipal bonds.
• Commodities: Commodity ETFs are popular with investors who want gold, silver, copper, oil, and other common global commodities.
• International ETFs: Global-based ETFs usually include country-specific funds, like an Asia ETF or a Europe ETF, which are made up of companies based in the country featured in the ETF.
• Emerging market ETFs: This type of ETF is composed of stocks from up-and-coming global economies like Indonesia and Argentina.
• Sector ETF: A sector ETF focused on an economic sector, like manufacturing, health care, climate change/green companies, and semiconductors, among others.
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4 Reasons to Consider Trading ETFs
Trading ETFs offers the same advantages (and risks) associated with trading common stocks. These features and benefits are at the top of the list.
1. ETFs Provide Liquidity
In a $6.49 trillion market, there is likely no shortage of investors looking to buy and sell ETFs. By and large, the bigger the market, the more liquidity it provides, and the easier it is to move in and out of positions.
2. There are Different Investment Options
With ETFs widely available in popular categories like stocks, bonds, commodities, and more recently, green industries and cryptocurrencies, ETF traders have plenty of investment choice.
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3. ETFs Offer Portfolio Diversity
Investment experts often extol the virtue of a diverse portfolio, i.e. one made up of both conservative and more aggressive investments that can balance one another and help reduce risk. With so many classes of ETFs available, it’s relatively easy to build an ETF trading portfolio that has different asset classes included.
4. ETFs Are Relatively Inexpensive to Trade
Exchange-traded funds are typically inexpensive to buy — the average fee for buying an ETF is just under 0.20 percent of the total asset purchased. Some brokerage platforms may offer commission-free ETFs.
What Are the Risks of Trading ETFs?
The main risk associated with trading ETFs is the same as with trading stocks — you could lose money. While shedding cash is always a threat when trading any security, the liquidity associated with exchange-traded funds makes it relatively easy to sell out of a position if needed. A candid conversation with a financial advisor may help investors deal with ETF investment trading risks.
How to Trade ETFs
Just as you can trade stocks, you can trade ETFs, too, by taking these steps.
Step 1. Choose a Trading Platform
Traditionally, investors trade stocks through a brokerage house or via an online broker more recently, on alternative trading platforms where investors can buy partial shares of a stock. As with most things in life, it’s generally a good idea to look around, kick some proverbial tires, and choose a broker with the best ETF trading services for you.
Investors can choose from different categories of ETF trading accounts, ranging from standard trading accounts with basic trading services to retirement accounts, specialty accounts, or managed portfolio accounts that offer portfolios managed by professional money managers. When looking for a good ETF trading platform, seek an account that offers the ability to regularly track market performance, create a unique portfolio trading plan, and “test” sample portfolios before you start trading for real.
Step 2. Select an ETF Trading Strategy
The path to successful ETF trading flows through good, sound portfolio construction and management.
That starts with leveraging two forms of investment strategy — technical or fundamental analysis.
• Technical analysis: This investment strategy leverages statistical trading data that can help predict market flows and make prudent ETF trading decisions. Technical analysis uses data in the form of asset prices, trading volume, and past performance to measure the potential effectiveness of a particular ETF.
• Fundamental analysis: This type of portfolio analysis takes a broader look at an ETF, based upon economic, market, and if necessary, sector conditions.
Fundamental analysis and technical analysis can be merged to build a trading consensus, typically with the help of an experienced money manager.
Any trading strategy used to build ETF assets will also depend on the investor’s unique investment needs and goals, and will likely focus on specific ETF portfolio diversification and management. For example, a retiree may trade more bond ETFs to help preserve capital, while a young millennial may engage in more stock-based ETF portfolio activity to help accumulate assets for the long haul.
Step 3. Make the Trade
Executing ETF trades is fairly straightforward for retail investors. It may be best to consider starting out with small positional trading, so that any rookie mistakes would be smaller ones, with less risk for one’s portfolio.
Here are two trading mechanisms that can get you up and running as an ETF trader:
• Market order. With market order trading, you buy or sell an ETF right now at the current share price, based on the bid and the ask — the price attached to a purchase or a sale of a security. A bid signifies the highest price another investor will pay for your ETF and the ask is the lowest price an ETF owner will sell fund shares. The difference between the two is known as the trading “spread.”
A word of caution on market trades. ETFs tend to have wider trading spreads than sticks, which could complicate you’re getting the ETF shares at the price you want. Share trading spreads of 10% are not uncommon when trading ETFs.
• Limit trade orders. An ETF limit order enables you to dictate terms on an ETF purchase or sale. With a limit order, you can set the top price you’ll pay for an ETF and the lowest price you’ll allow when selling an ETF.
For investors who have qualms about buying or selling an ETF at a fixed price, limit orders can be a viable option, as they allow the investor to set the terms for a trade and walk away from an ETF trade if those terms aren’t met.
Historically, exchange traded funds have been used primarily as passive, “buy and sell investments.” But as asset trading grows more exotic in the digital age, trading ETFs has become increasingly popular.
As with any investment, a smart investor will perform their due diligence, tread cautiously, and work with a financial professional as needed. Ready to start investing in ETFs? With a SoFi Invest® online brokerage account, investors can choose from ETFs that are intelligently diversified and auto-rebalanced.
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