Just like an individual stock, an exchange-traded fund (ETF) can be bought and sold freely via an exchange. This dynamic ability gives traders the option to make quick intraday trades to seek a profit.
“Some investors gloss over the “exchange-traded” in “exchange-traded fund,” failing to understand or appreciate those two words and the implications of investing in a fund that trades like a stock,” said Ben Johnson in Morningstar. “The exchange-traded nature of these funds is increasingly taken for granted, as many of the largest ETFs trade at tight spreads in very narrow bands around their net asset values through most market conditions. But not all ETFs are created equal from a liquidity perspective, and investors shouldn’t take ETFs’ liquidity for granted.
“In addition, the market mechanisms that underpin the ETF ecosystem have experienced hiccups of varying magnitude, ranging from the “flash crash” in 2010 and the early-morning meltdown witnessed on Aug. 24, 2015, to more sporadic episodes of lesser scope and impact,” added Johnson. “These events have served as painful reminders of why investors should exercise caution when buying and selling ETF shares.”
Traders can also take advantage of leveraged ETFs in order to capitalize on the short-term momentum of a specific ETF. What is leverage and how can an investor incorporate leveraged ETFs into his or her portfolio?
If an investor is betting that a specific sector or stock will go down, he or she will have to short that stock or group of stocks. Furthermore, shorting stocks are typically bought on margin, meaning the investor will have to borrow the money from the broker–known as leverage.
With an inverse ETF, an investor can be bearish without having to buy the securities on margin. If an investor does wish to leverage a trade, there are leveraged ETFs available that allow investors to amplify their returns by multiples of 1.25, 2 or 3 times, depending on the ETF product.
The amount of leverage will depend on how aggressive the trader wants to get. Investors who are new to leveraged ETF trading can opt for lesser leverage to test out the waters.
Here are 5 Tips Johnson offered when it comes to trading ETFs:
- Use limit orders
- Trade when the market is open
- Don’t trade near the open or close of the market hours
- Get professional assistance during a big trade
- Consider a mutual fund if trading ETFs isn’t your preference
Pointing Traders to the Right Direxion
Direxion Investments offers leveraged ETFs to traders who want to trade both sides of a move whether they take the long (bullish) side or short (bearish) side. Furthermore, their funds offer traders exposure to varying levels of leverage—all the way up to three times the leverage.
How much a trader wants to expose themselves to leverage will depend on how much risk they would like to assume. For those leaning on the short side of a trade, but don’t want to assume heavy risk, Direxion offers funds with 1x leverage.
This article originally appeared on ETFTrends.com.
