Wednesday, May 13, 2009

ETFs Trading

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ETFs (Exchange Traded Funds) was launched in 1993 with introduction of SPDRs (ticker: SPY) that tracks the S&P 500 index. Still SPDRs remains as one of the most traded stock (not just exchange traded funds) on the U.S. stock market. ETFs should always be look at as funds that could be traded as.

To see advantages of ETFs trading the one should compare them to mutual funds trading first and then to stock trading. By comparing ETFs to the mutual funds we may see that:

  1. Intraday Trading: Mutual funds are always traded at the market close once a day and no matter when you place order to buy/sell mutual fund your order will be filled at the same time (at market close) and at the same price as orders of all other investors. Exchange traded funds could be traded as stock and you can purchase or sell them during the market trading hours. The ETFs provide investors with intraday trading flexibility of stocks which allow benefiting from the intraday price movements;
  2.  Ability to Sell Short: As a rule when you invest into mutual funds you buy them - you cannot sell them short to open a position. For this purpose you have to look for inverse or Bear funds. That means that you have switch between bull and bear funds or participate in trading only in Bull markets (as a rule only index funds has inverse funds). In case of ETF, as was mentioned above, you trade it as stock, furthermore, you may sell it short and participate in Bear markets as well without looking for additional trading vehicle. Because of that, ETFs provide investors with wider range of speculative trading strategies in comparison to mutual funds;
  3.  Low Cost: Exchange traded funds are considered as cost efficient trading tools. Because of their low cost a lot of professional and retail investors chose them for investments.

By comparing ETFs to stocks we may see other three points:

  1.  Diversification: When you purchase a single share of ETF you invest into all stocks from the basket of the index this ETF tracks. For instance, by buying one share of QQQQ at $40, you invest into all 100 companies listed in the Nasdaq 100 index. Try to imagine how much it would cost you to buy one share of each company from the Nasdaq 100 index in order to get similar diversification;
  2.  More conservative than stocks: The ETF price cannot drop to zero, ETF cannot be broke and it cannot file a bankruptcy. If you see it then this is The End. Index listing is managed by professionals: weak companies are reviewed on a regular basis and when it is necessary are replaced by the stronger companies. In case of DJI the listing is managed by “Wall Street Journal”, in case of S&P 500 the listing is managed by Standards & Poors, Nasdaq 100 index is managed by Nasdaq OMX, etc. They basically do portfolio selection and all fundamental analysis instead of you;
  3.  Easier to analyze: By having several stocks in your portfolio, it could become complicated to analyze them. You have to do some fundamental analysis for each stock, look at chart and do some technical analysis and in addition it is recommended to analyze indexes that cover your stock to see your industry and whole market general trend. It could be quite complicated and time consuming. The ETFs analysis is simpler and very often it could be narrowed to technical analysis of indexes only.

As you may see that ETFs have become very popular because they attract mutual fund investors by their low cost, tax efficiency, saved features of the mutual funds and obtained flexibility of stocks. At the same time ETFs attract stock investors by their ability to diversify portfolio, simplified analysis, protection from bankruptcy. I may say that it is easy to understand why ETFs has become the most popular trading vehicle among all type investors, including large institutional investors, small speculators and active traders. Exchange traded funds have become very liquid (you may sell and buy them very fast) which is another important advantage. Some of the most traded ETFs are: SPY (tracks the S&P 500 index), XLF (tracks the S&P Financials), QQQQ (tracks the Nasdaq 100 index), DIA (tracks the Dow index), IWM (tracks the Russell 2000 index), etc.

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