ETFs
What are ETFs?
Exchange traded funds (ETFs) are baskets of securities with an underlying index that trade all day on an exchange like a stock.
How long have they been around?
Since 1993. The first ETF, the SPDRS (SPY), tracked the S&P 500. The strategy of indexing is not new, however. Barclay’s created it in 1971.
What are the advantages of ETFs?
- You always know what you’re buying, because they replicate indexes. The holdings of those indexes are easily available and posted daily.
- ETFs offer safety in numbers. They have more diversification because they’re a basket of stocks rather than one individual stock.
- Their performance can be easily tracked.
- ETFs tend to have lower expenses and fees because they passively track indexes. There are no additional fees to pay to a fund manager. The average fee for a mutual fund is about 1.6%, while for a large-cap growth ETF it’s about 0.15%.
- They’re tax efficient because investors rarely generate capital gains.
Can you suggest any investing strategies?
A strategy we recommend is to look for funds that are above their 200-day moving average. There are always areas that are trending up as others are going down. To learn more about this strategy and how to employ it, read our special report on trend following.
How do I know it’s time to sell my ETF?
No matter what you buy, it’s important to have a stop loss point and remove your emotions. We sell a fund when it falls 8% below its recent high or below its trend line (the 200-day moving average). We discuss this strategy and the logic behind it in more detail here.
I sold my ETF. Now what?
- Treat the newly available cash as “free agent” funds. Just because you sold an ETF doesn’t mean you’re obligated to buy it back when it rebounds.
- Look for ETFs that are above or rising above their trend lines.
- Look for ETFs with positive, relative strength. When markets rebound off a low, it’s usually those with the greatest momentum that enjoy sustained uptrends.
What are the different types of indexing?
Typical indices weight companies according to their stock market valuation, or market capitalization. This value is calculated by multiplying the total number of outstanding shares by the stock’s price. On the other hand, fundamental indexes base stocks on characteristics such as book value, cash flow, sales and/or dividends.
What are short ETFs? What do they do?
Short ETF are designed to either perform the opposite or double the opposite of an index. If an index goes down, a short ETF will go up. An UltraShort or 2x Inverse ETF will go up twice that.
We explain how they work in greater detail here.
What is the difference between an ETF and an ETN?
Exchange traded notes (ETNs) are distant relatives of the ETF and they come with their own unique issues attached. When you own an ETN, you’re investing in a 30-year debt instrument. They are a promise by the provider to pay the investor the amount reflecting a change in the underlying index.
ETNs do have some tracking error, but the difference is that they will never trade below the value of their index. This is part of what the provider offers to the investor. However, there’s no guarantee that they won’t trade above their net asset value (NAV). With ETFs, any tracking error is borne by the investor.
About ETF Trends
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Where can I see which ETFs are moving above their long-term trend lines?
We now have an ETF Analyzer, where you can get all kinds of detailed performance information about any fund. If you have suggestions for something you’d like to see in particular, don’t hesitate to contact us at [email protected].
Where can I buy Tom Lydon’s books?
The ETF Trend Following Playbook and iMoney: Profitable Exchange-Traded Fund Strategies for Every Investor are available in bookstores and at major online book retailers. For more information, visit our book page.