An Exchange Traded Fund (ETF) is a fund that tracks an index. It holds in its portfolio the shares that make up the index. It’s a great way to diversify at a low cost because diversification is built into the product. It’s liquid too. It trades at the exchange like a normal share. [There’s loads of info on ETFs here, in addition to our regular ETF blog.]
This built-in diversification makes ETFs less susceptible to high volatility levels and they can hold a trend for a long time. They’re slow at the turns, in contrast to equities which are more volatile and generally quick at the turns. This makes ETFs great instruments for investing because they’re psychologically easier to hold.
Because of the general market profile of ETFs, they are a lower risk than equities, especially when using leverage. They have strong trends (slow, but strong), which is great for trend followers. Since they trade just like shares you can short them too. I wouldn’t normally recommend shorting anything. But shorting ETFs is better than shorting equities because the turns are typically slower and more forgiving.
ETFs are unlikely to have a hyper-move up or down and they’re not susceptible to single event risk. You will hardly ever find an ETF down/up +5% in a day because of some event. That happens all the time in shares, which can be painful if you’re on the wrong side of the move. This makes ETFs the perfect instrument to trade for developing traders – you don’t have to worry about volatility while you’re developing your trading skills.
What happens when an ETF I’m trading pays dividends?
Well if you are long, the dividend will be paid out to you like in a normal share. However when you short, you would be liable for that dividend. Remember when you short something you have borrowed that from someone who is due their dividends, so you pay. Like in equities the ETF would drop by the dividend amount on LTD.
To close off I’d say particularly to developing traders who’re still finding their feet in the market, that ETFs are a great place to start. You can move into other instruments once you’ve fully developed your edge.
Village Trader blog
Traders share a peculiar characteristic: they’re fiercely competitive, but only with themselves. In practice this means that they see every outcome as an opportunity to learn, and they’re brutally honest about both their failures and successes. This also means that they’re hungry for knowledge. They don’t sleep easy with unanswered questions. And they’re seldom satisfied with just one answer.
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