ETF Trading, Truth and Transparency
One of the questions many traders new to the world of exchange-traded funds have is this: “I know that ETFs trade like stocks. But beyond that, are all ETFs created equal?”
There are a few important distinctions that more and more ETF traders and investors have begun to figure out about exchange-traded funds. But perhaps the most important one is that you must make sure you know exactly what your ETF is tracking.
If you believe that the price of oil is going up – but don’t have much of an opinion on how that might affect oil stocks – then why trade or invest in an “oil ETF” that actually tracks the price of oil stocks, instead of one that follows the price of crude oil itself? But that’s what too many ETF traders and investors do, buying an ETF like the Energy Select Sector SPDRS ETF, XLE
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The same is true for a variety of commodity ETFs. Simply double-checking to see what the holdings of a given ETF are, or the index it tracks, can avoid making what can be a costly mistake.
Another factor for ETF traders and investors to consider when selecting ETFs is weighting. Some ETFs are so heavily weighted toward a few stocks that traders may not get the sector diversification that they think they are getting when they buy the fund. Consider, for example, the Biotechnology HOLDRs or BBH
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One of the great virtues of exchange-traded funds compared to mutual funds and closed end funds is their transparency. And ETF traders and investors should make sure they take advantage of this by peeking under the hood and making sure their ETF has everything they want in it – and little more – before taking that trade or investment out on the open road.
According to a recent report, eight out of ten securities traded are exchange-traded funds. Want to learn how to trade them? Click here to find out what traders are saying about Larry Connors’ new book, Short Term Trading Strategies That Work: A Quantified Guide to Trading Stocks and ETFs!
David Penn is Editor in Chief at TradingMarkets.com.