ETF Trading: Are Exchange-Traded Funds Safer Than Stocks?

More Diversification. Less Volatility. More Flexibility. It’s no surprise why a growing number of investors and traders are turning to exchange-traded funds (ETFs) to help them manage and grow their money over time.

Today I want to take up the first aspect of what makes ETFs such an attractive option for investors and traders alike: the idea of ETF trading as a potentially safer alternative to stock trading.

When it comes to ETF trading, one significant point to keep in mind is the fact that ETFs represent not a single stock, but a group of stocks. For example, the ^XLF^, one of the more popular and widely traded sector funds, includes over 80 financial stocks – from ^BEN^ to ^BAC^.

XLF chart

And this is specifically why ETFs are becoming so popular: they provide greater diversification.

For example, while any one stock in the XLF may suffer a major loss – the company behind the stock could even go out of business! – the likelihood that ALL 81 companies in the XLF would go out of business is very small, to say the least.

Exchange-traded funds help traders and investors avoid what is called corporate or single stock risk. This is the risk that any one stock may suffer a major drawdown far beyond that of the rest of the market.

Using exchange-traded funds instead of individual stocks is one of the easiest ways to avoid this risk. In buying, for example, a technology exchange-traded fund composed of many different technology stocks, rather than a single technology stock, a trader or investor no longer has to worry about being a champion stock picker.

XLK chart

All of the top stocks will be in the fund. And owning the fund, for an investment or a trade, provides exposure to the general technology sector, without taking on the risk that things might not work out with any individual technology stock.

Tomorrow we’ll look at another reason why exchange-traded fund or ETF trading can be safer than stocks – the question of volatility.

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David Penn is Editor in Chief of