ETFs are investment mechanisms that are based on tracking the performance of particular commodities, stocks, or market indices. They can also include tracking of different combinations of stocks within and across sectors. These can then be traded the same way as stocks in the securities markets.
Exchange-Traded Funds (ETFs) offer investors great opportunities to benefit from the price actions of stocks and other securities without having to own them. ETFs are traded in securities markets like NYSE. One of the major gains investors can derive from ETFs is the exposure to diverse stocks, bonds, etc., without having to get into the nitty-gritty of the individual assets’ trading dynamics.
Types of ETFs
As deduced from the name, these are ETFs that combine different assets and put them under a single management fund. The key driver, in this case, is usually optimizing the potential benefits of a mixed fund whereby they all stand a good chance of appreciation. In case some underlying assets fail, the other assets in the fund will provide a hedge against net losses.
Basic index ETFs
These are hinged on market indices. Their performance is therefore based on the margins of movement within indices like NIKKEI, Dow Jones Industrial Average, etc. The best way to get the most out of these ETFs is to blend a good mix of best-performing indices based on fundamental and technical analysis.
Style and factor ETFs
These are fund portfolios created from a blend of selected stocks as well as bonds. The stock component should have assets of companies consisting of large market caps, medium market, and low market capitalization stocks. Such a mix is a way of spreading risks and optimizing chances of making net profits. The “factor” aspect incorporates stable assets like bonds, which have comparatively lower profit margins but are a safer bet than stocks.
Economic performance varies from one country to another, sometimes due to geo-political reasons. Investors who are keen on these dynamics usually leverage international ETFs to gain from the high economic returns in other countries.
These are high-risk ETFs that allow investors to use borrowed money to invest in assets whose values outweigh the investor’s funds. These ETFs usually multiply the actual market performance. Leveraged ETFs are high-risk ventures that can lead to exponential profits or massive losses if the market goes against a trader’s position.
These offer an alternative way of investing for those who hold contrarian views of a market. For example, an investor who feels that the S&P 500 will drop in value can gain 10% if the index falls by ten percentage points and vice versa.
Socially responsible ETFs
These are ETFs whose components are companies with an outstanding record in social responsibility, environmental protection, and good corporate governance.
ETF investment strategies
Use ETFs to cushion against risks
This is a means of optimizing profits and safeguarding your standing against losses. You can do this by having ETFs positioned against your stock portfolio. For example, if you have a gold stock, you can have an inverse ETF for gold to protect your position in case gold loses value.
ETFs as a cushion in market indices
As discussed above regarding stocks, you can also have ETFs positioned to guard you against the downturns of market indices. You can have different ETFs protecting you against potential losses in your index position. By looking at the possible net gains and possible net losses, you can determine the best ETF combinations to sufficiently cover your positions.
Use ETFs to your advantage during seasonal swings
Earnings reports usually have an impact on the performance of assets. Using the economic calendar, you can plan ahead and invest in your ETFs in a manner that ensures that your portfolio caters to potential surprises in earnings reports. In addition, you can use the ETF straddles option to safeguard against potential volatility in earnings outcomes.
Know that leveraged ETFs are landmines
If you are a newbie, then you should always dismiss the idea of going for leveraged ETFs. However enticing they are, the chances of profiting from these debt-funded ventures are quite slim. These ETFs give investors the chance to punch above their weight, but often with costly consequences. These ETFs have less net gains during upswings than net losses during downturns, with additional expense ratios increasing loss margins. Therefore, for example, a 10% rise in index value, followed by an 8% decline, may result in a break-even or net loss.
ETFs are excellent ways of investing and present investors with several ways in which they can hedge their losses and optimize their profits. Understanding the various types of options in ETFs is key to succeeding in this type of investment. In addition, you also need to know the right mix of ETFs to trade in, among other strategies. Finally, ETFs also have their risk factors, and you should therefore ensure that you adequately cover your positions.