Investing in ETFs (Exchange-Traded Funds) has become both extremely popular and yes, very easy. Many of the pitfalls or challenges you might encounter when investing in mutual funds do not apply to ETFs. This advantage has led many former mutual fund investors to ETFs.
ETFs are similar to mutual funds because an ETF represents investments in a number of stocks. For example:
- IYE – iShares Dow Energy holds various energy stocks
- EWZ – iShares Brazil holds various Brazilian stocks
- SHY – iShares 1-3 Yr Treasury Bonds holds various 1-3 year bonds
There are many hundreds of ETFs available and new ones are being created by different companies on a regular basis. As with mutual funds, you can create groups (or universes) of ETFs, and these will be the basis for your investment positions.
Groups may include:
Why you should invest with ETFs – for Profitable Safe Investing – Because ETFs trade like stocks, you can buy or sell at any time without any restrictions. This is one of the biggest differences between ETFs and mutual funds. Some brokers have responded positively to the shift toward ETFs by allowing clients to trade some ETFs without charging a trading fee.
One of the other differences between ETFs and mutual funds is that ETFs are not actively managed. That means that an ETF owner, like iShares, puts together the ETFs group, but doesn’t trade stocks in and out of the group in order to find the best current holdings.
Like anything else, there are a few potential pitfalls in trading ETFs. Because many are new or they cover such a small niche area of the market, their trading volume may be quite low. This means you may not be able to sell when you want to if you pick one of these new or small niche ETFs. It also means that the new or niche ETFs many not even last; many have declined and completely disappeared in the last few years simply because of lack of interest. Simple screening on the internet or using an investment software program that can show you volume or that provides you with groups of proven ETFs will help you avoid these pitfalls.
Trading strategies with ETFs can be similar to those for trading stocks. You can go in and out as often as you desire. You can trade daily, weekly, or however frequently you desire by developing strategies based on your preferences. I usually have multiple strategies for the same group, e.g., sectors based on semi-frequent trading (no more than once a week) and infrequent trading (no more than once a month).
Personally I find it easier to trade ETS because I don’t have to constantly think about the various mutual fund trading factors/restrictions. At the same time, I get a degree of diversification – instead of putting all my eggs in one basket by buying one particular stock – the ETF offers me a variety of stocks so I can hedge my bets. ETFs also offer many options for developing strategies.
Typical screening methods for ETFS are offered by most brokerage websites. These will allow you to screen based on performance over different time periods, by industry, or by economic sector. Trading based on these methods is the most elementary.
Good ETF investment strategies require a bit more work and decision making that those for stocks and mutual funds. Just a few years ago there were less than a few hundred ETFs, now the number is over a thousand and growing daily. When there were fewer than 200 options it was relatively easy to choose where to invest, now, like stocks and mutual funds, the choices are more complex and can be intimidating…but they don’t need to be.
Developing an ETF trading strategy relies on the principle of divide and conquer, and separating the weak from the strong. You can do this by reading…I’m talking alot of reading, and studying charts…lots of charts, or you can avoid the stress and use an investment software program that will allow you to easily sort the ETFs into manageable groups from which you can find strong, profitable ETF winners.
Trying to find a few strong wining candidates from a thousand or so symbols has a variety of pitfalls that ultimately leads either to defeat or to mediocre results. These pitfalls occur because of the similarity between symbols e.g., foreign ETFs based on China or Japan may all be clumped together, or all the bond ETFs may be clumped-these clumps can hide or camouflage potential winners.
My first suggestion is to divide and conquer – separate the ETFs into categories. Some ETFs may fall into two or three categories – and that’s okay as long as you don’t overdo it.
Categories that I use include:
By dividing the ETF symbols into categories you have a better chance of finding potential winners. Each group may not grow or produce winners at the same time but that allows you to easily shift to a group that is growing or to a ticker symbol that can make you money. It is always easier to appreciate the blooms on a single cherry tree in the park than it is to pick out the most attractive tree in the forest a mile away. It is the same with your ETFs. It is much easier to spot trends and winners from within small groups than it is from watching all the symbols on the stock exchange.
The second strategy, separating the weak form the strong, is all about finding those tickers that will make you money and keep you on the path of safe investing. This can be accomplished a variety of ways.
A few keys to finding winners:
- Study Charts
- Screen for Performance
- Relative Strength Analysis
I am partial to using relative strength analysis, Alpha and relative strength momentum (RSM) in particular, to separate the leaders from the followers. After I have found the leaders within my groups I set up signals both to safeguard my money against dramatic losses and to lock in my future profits. Yes, you can do this using a program like Excel or, if you value your time, you can use an investment software program. Once I stalled my investment software program, I used Alpha to find the best “buy” ETF candidates. Then I reviewed a few of the charts to verify the ETF recommendations – once I had these results I was ready to place my buy orders.
Dominick is the designer of the investment program Dynamic Investor Pro, an investment software used by individual investors and professional investment advisors for stocks, ETFs or mutual funds and the author of the book, Invest Safely and Profitably.