ETFs

ETFs are exchang traded funds, being very powerful financial products. By exchange-traded fund we mean that there is a fund manager that buys and sells financial assets (such as stocks, currencies, bonds, even other funds, commodities, etc.) in order to match the performance of its portfolio to a certain objective. The objective can range from replicating a certain index, or a certain bond, or even gold, silver, etc. to replicating combinations of markets or sectors, such as the technology sector, or the energy sector, or the European or Asian market.

The fund manager divides the fund into small parts and markets them, so that we can invest in them with small amounts.

In practice, they work in a similar way to stocks, i.e. they are bought or sold in whole units and, in some cases, generate dividends.

Characteristics of an Exchange Traded Fund ETF

  • There are a large number of ETFs
  • They are ideal for long term trading, and some like SPY for intraday trading.
  • They are products created and marketed by fund managers, so you have to know how to choose them, as they have management costs.
  • There are inverse and leveraged ETFs, allowing for riskier but potentially higher returns. As the saying goes, “the greater the risk, the greater the gain”.
  • They are inexpensive and versatile
  • They are traded in the same markets as stocks, and while there are good ETFs in other markets, the ideal is to trade those in the US market, as they are usually the cheapest and most liquid, due to the fact that the big ETFs in the world, such as SPY, are in this market. If you have a US broker, you can simply look to see if you can buy SPY, if so it is because your broker allows you to buy ETFs.

The SPY is the Standard & Poor’s 500 index ETF (one of the most traded in the world) which represents the 500 largest companies in the United States for example, and allows you to invest generically in that market without having to choose a particular stock, or two, but you choose the whole market. Or if for example you want to invest only in the US financial sector you can trade the ETF called XLF. The choices are many.

What are the best Echange Traded Funds?

To choose good ETFs you have to take into account their cost and liquidity.

The cost is measured with a parameter called “Expense ratio” and should be as low as possible, since the price is proportional to the number of clients interested in the ETF of the manager, so the more clients, the lower the cost.

You should compare prices of similar ETFs, which replicate similar assets or combinations. Comparing the SPY to the German bond ETF will not help.

In the Resources section, “news portals”, you will find sites to find good ETFs and information about them.

Whenever you look at an ETF for analysis, look for the Expense ratio, so you have an idea of how much you are paying the fund manager.

With regard to liquidity, we should check that there is a market with a lot of people trading the ETF we are looking at. That is to say, it should be easy to buy or sell, otherwise we would be taking a pointless risk as the buying or selling price can make a big difference. The lower the cost of the ETF, the more liquid it is. Therefore, if you choose a cheap ETF, it is very likely to be liquid. The ideal is to look at its price chart, the more continuous and fluid the price movement, the more liquid it is. Here is an example of the world’s most traded ETF, the SPY on daily candles:

As you can see, the price is continuous, without so many jumps and has good trading volume. It moves a lot.

IMPORTANT RECOMMENDATION: Try to avoid inverse ETFs and leveraged ETFs. They are usually expensive and illiquid. Inverse ETFs are those that go in the opposite direction of the market and leveraged ETFs are those that amplify by 2x or 3x to take better advantage of the performance of a move. But just as they amplify the gain, they also amplify the loss. Trading this type of ETFs is not for beginners, it is for people with a lot of experience. Anyway, if you want to try it, remember to do it in demo for a long time.
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