Although there are some very important differences between them, it's easy to understand ETFs if you think of them like mutual funds.
But unlike mutual funds, which try to beat indexes like the S&P 500 each year, ETFs try to mirror them.
For example, if the S&P 500 trades 10 percent higher, the ETF that mirrors it will also trade 10 percent higher. If the S&P 500 index trades 12 percent lower, the ETF that mirrors it will also decline by 12 percent.
It wasn't until recently that a new breed of ETFs really came of age. That's because they don't just mirror the performance of indexes like the S&P 500 anymore.
The new ETFs mirror the performance of entire industry groups, or sectors. Like the Software sector or the Housing sector or the Energy sector or a whole country.
Here's an example of how ETFs mirror sectors, using the Oil Services sector as an example.
I've been bullish on the Oil Services sector recently.
But the Oil Services sector, like all sectors, is comprised of dozens of individual stocks. That means that to mimic the performance of the entire sector, you'd have to be rich enough equally buy each and every individual stock in that sector.
You'd also have to have the time and the experience to research each stock to pick the best ones with the greatest profit potential, and to avoid a disaster like Enron among them.
Instead of buying all the stocks in the energy sector, you can now just buy shares of the Proshares Ultra Oil & Gas ETF (SYM: DIG). Since the returns mirror the sector investors who bought DIG when my trading system turned bullish made easy profits of 17% in a few days with total risk of only 2%. Not all trades are that easy, but it does happen from time to time.
As you can see from above, having the ability to easily trade sectors is one of the biggest benefits of the new generation of Exchange Traded Funds. However, having access to this tool does not automatically make you a successful investor.
The key to the 17% profits detailed above was knowing that the Oil Services Sector was about to make a big move. The way I teach my students to know is to follow price. Price always includes all fundamental knowledge.
By the end of these emails, my goal is not only to make you comfortable with the concept behind ETFs, but also to give you some of the tools ETF Trend Trading paid students use to be profitable trading ETFs.
Their free videos share more information that will set you apart from every other individual investor in the market. They can be accessed from my homepage.
Here is small condensed list of the benefits of trading ETFs:
- Mirror indexes or sectors without having to buy hundreds of stocks.
- Lower expense ratios. While mutual funds can charge 1% to 3%, or more, ETFs are almost always in the 0.1% to 1% range. Over the long term, these cost differences can compound into a noticeable difference.
- Unlike mutual funds ETFs trade intraday like individual stocks. For instance, you can sell short, use a limit order, use a stop-loss order, buy on margin, and invest as much or as little money as you wish (there is no minimum investment requirement).
- Diversification. This is one of the keys to long term investing success.
- Tax Benefits. Pay lower taxes than most mutual funds.
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About the Author:
Rob Trader - Forex Expert
http://tradingtoollist.co.cc/