ETF Trading: How Stock Traders Use Exchange-Traded Funds to Improve Performance
We took a look at one reason why more stock traders are adding exchange-traded funds to their overall trading strategy (read “Are Exchange-Traded Funds Safer Than Stocks?”.
Using exchange-traded funds instead of individual stocks is one of the easiest ways to avoid (single stock) 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.
Another feature of ETF trading for short term traders is that many of the quantified strategies for ETFs have higher accuracy rates than quantified strategies for stocks.
Consider the short term ETF trading strategies in High Probability ETF Trading by Larry Connors and Cesar Alvarez (learn more about the book here).
These ETF trading strategies have historical winning percentages of well over 70% in widely-traded ETFs like the ^SPY^, the ^QQQ^ and the ^IWM^. Aggressive versions of these strategies have historical win rates more than 80%.
It is rare to find a stock trading strategy that has similarly predictable winning percentages. Stock trading strategies provide short term traders with exposure to a broad range of potential opportunities every trading day. The returns from these trades can vary widely over a range and be harder to predict. Because more of these trades will tend to be at the higher end of this range when using a high probability stock trading strategy, high probability stock trading strategies make sense for most short term traders.
The returns from quantified ETF trading strategies, on the other hand, tend to be more predictable than most quantified stock trading strategies. For conservative swing traders, this alone is one attraction of ETF trading.
When combined with stock trading, ETF trading can help make the returns of an overall trading portfolio more predictable. This is in part because of the historically high returns from quantified ETF trading strategies (more at High Probability ETF Trading link above). Adding ETF trading can also smooth the overall returns of a stock portfolio, because of the tendency of the returns from ETF trading to vary less compared to the returns from stock trading.
David Penn is Editor in Chief of TradingMarkets.com