7 best ETF trading strategies for beginners
Exchange Traded Funds (ETFs) are ideal for newbie investors due to their many advantages such as low expense ratios, abundant liquidity, range of investment choices, diversification, low investment threshold, etc. These characteristics also make ETFs perfect vehicles for various trading and investing strategies used by new traders and investors. Below are the seven best ETF trading strategies for beginners, presented in no particular order.
Key points to remember
- ETFs are an increasingly popular product for traders and investors who capture indices or large sectors in a single security.
- ETFs also exist for various asset classes, as leveraged investments that return a certain multiple of the underlying index, or inverse ETFs whose value increases when the index falls.
- Due to their unique nature, there are several strategies that can be used to maximize investment in ETFs.
1. Average cost in dollars
We start with the most basic strategy: the average cost in dollars. Average dollar cost is the technique of buying a fixed dollar amount of an asset on a regular schedule regardless of the changing cost of the asset. Beginner investors are usually young people who have been in the workforce for a year or two and have a stable income with which they can save a little each month.
These investors should take a few hundred dollars each month and, instead of putting them in a low interest savings account, invest them in an ETF or a group of ETFs.
Periodic investing has two major advantages for beginners. The first is that it confers discipline on the savings process. As many financial planners recommend, it makes perfect sense to pay yourself first, which is what you get by saving regularly.
The second benefit is that by investing the same fixed amount in an ETF each month – the rule of thumb of averaging dollar costs – you will accumulate more units when the ETF price is low and fewer units. when the price of the ETF is high, so by averaging the cost of your holdings. Over time, this approach can pay off, as long as you stick to the discipline.
For example, suppose you invested $ 500 on the first of each month from September 2012 to August 2015 in the SPDR S&P 500 ETF (SPY), an ETF that tracks the S&P 500 Index.So when SPY units traded at $ 136.16 in September 2012, $ 500 would have earned you 3.67 units, but three years later when units traded near $ 200, a monthly investment of $ 500. would have given you 2.53 units.
Over the three year period, you would have purchased a total of 103.79 SPY units (based on the closing prices adjusted for dividends and splits). At the closing price of $ 209.42 on August 14, 2015, these units would have been worth $ 21,735, for an average annual return of nearly 13%.
2. Asset allocation
Asset allocation, which means allocating part of a portfolio to different asset classes, such as stocks, bonds, commodities and cash for diversification purposes, is a powerful investment tool. . The low investment threshold of most ETFs makes it easy for a beginner to implement a basic asset allocation strategy, depending on their time horizon and risk tolerance.
For example, young investors may be 100% invested in equity ETFs when they are in their 20s due to their long investment horizons and high risk tolerance. But as they reach their 30s and embark on major life cycle changes, such as starting a family and buying a home, they may switch to a less aggressive investment mix, like 60% in ETFs. equities and 40% in bond ETFs.
3. Swing Trading
Swing trades are trades that seek to take advantage of large fluctuations in stocks or other instruments like currencies or commodities. They can take anywhere from a few days to a few weeks to complete, unlike day trades, which are rarely left open overnight.
The attributes of ETFs that make them suitable for swing trading are their diversification and tight bid / ask spreads. Additionally, as ETFs are available for many different investment classes and a wide range of sectors, a beginner can choose to trade an ETF based on a sector or asset class in which they have expertise or knowledge. specific.
For example, someone with a technological background may have an advantage trading a technology ETF like the Invesco QQQ ETF (QQQ), which tracks the Nasdaq-100 index.A novice trader who closely follows the commodities markets may prefer to trade one of the many commodity ETFs available, such as the Invesco DB Commodity Index (DBC) tracking fund.
Since ETFs are typically baskets of stocks or other assets, they may not exhibit the same degree of upward price movement as a single stock in a bull market. Likewise, their diversification also makes them less sensitive than individual stocks to a sharp decline. This provides some protection against capital erosion, which is an important consideration for beginners.
4. Sector rotation
ETFs also make it relatively easy for beginners to execute a sector rotation, depending on the different stages of the business cycle. For example, suppose an investor has invested in the biotech industry through the iShares Nasdaq Biotechnology ETF (IBB).An investor may wish to take profits in this ETF and look to a more defensive sector such as consumer staples through the Consumer Staples Select Sector SPDR Fund (XLP).
5. Short selling
The short sale, the sale of a borrowed security or a financial instrument, is generally a fairly risky venture for most investors and not something most newbies should attempt. However, short selling through ETFs is preferable to short selling individual stocks due to the lower risk of a short squeeze – a trading scenario in which a security or commodity that has been heavily shorted goes up in price. arrow – as well as the significantly lower cost of borrowing (compared to with the cost of trying to short sell a stock with high short interest). These risk mitigation considerations are important for a beginner.
Short selling via ETFs also allows a trader to profit from a broad investment theme. So an advanced beginner (if such an oxymoron exists) who knows the risks of short selling and wants to initiate a short position in emerging markets could do so via the iShares MSCI Emerging Markets (EEM) ETF.However, note that beginners avoid double- or triple-leveraged inverse ETFs, which seek results equal to two or three times the inverse of the one-day price change in an index, due to the degree of risk. significantly higher inherent in these ETFs.
6. Bet on seasonal trends
ETFs are also good tools for beginners to capitalize on seasonal trends. Consider two well-known seasonal trends. The first is called the May Selling Phenomenon and goes. It refers to the fact that US stocks have historically underperformed over the six month period May to October, compared to the period November to April.
The other seasonal trend is the trend for gold to earn in September and October, thanks to strong demand from India ahead of the wedding season and the Diwali Festival of Lights, which usually takes place between mid-October. and mid-November.The general trend of market weakness can be exploited by selling the SPDR S&P 500 ETF in late April or early May, and closing the short position at the end of October, just after that month’s typical market fades.
A newbie can also take advantage of the seasonal strength of gold by purchasing shares of a popular gold ETF, like the SPDR Gold Trust (GLD), at the end of the summer and closing the position after a few. month.Note that seasonal trends do not always happen as expected, and stop-losses are generally recommended for such trading positions to limit the risk of large losses.
A newbie may occasionally need to hedge or hedge against downside risk in a substantial portfolio, perhaps one that was acquired as a result of an inheritance.
Suppose you have inherited a large portfolio of US blue chips and are worried about the risk of a large drop in US stocks. One solution is to buy put options. However, since most beginners are not familiar with options trading strategies, another strategy is to initiate a short position in broad market ETFs like the SPDR S&P 500 ETF or the SPDR Dow Jones Industrial Average. ETF (DIA).
If the market goes down as expected, your position in blue chip stocks will be effectively hedged as declines in your portfolio will be offset by gains from the short ETF position. Note that your gains would also be capped if the market moved higher, as gains in your portfolio will be offset by losses from the ETF’s short position. Nonetheless, ETFs offer beginners a relatively simple and effective method of hedging.
The bottom line
Exchange traded funds have many characteristics that make them ideal instruments for traders and novice investors. Some ETF trading strategies that are particularly suitable for beginners are cost averaging in dollars, asset allocation, swing trading, sector rotation, short selling, seasonal trends, and hedging.