What are ETFs - ETFs stocks explained

Whether you are brand new to the world of online trading or if you’ve just never gotten around to using ETFs, traders ultimately ask themselves “what are ETFs?” when they come across this type of investment fund. So, let’s try and answer the question “what are ETFs?” so that you can diversify and strengthen your trading prowess.

An ETF is a simple concept to understand actually, as it is simply a fund that contains many different underlying assets. The key here is not to confuse an ETF with a mutual fund. An ETF can trade throughout the whole day while a mutual fund only trades once at the end of every day. A fairly distinctive difference. Much like a Russian doll, an ETF is essentially a security that contains a number of different securities. An ETF is traded on an exchange, exactly how you would trade individual stocks. Hence the name, Exchange Traded Fund.

You have plenty of options available to you when choosing from exchange traded funds, as ETFs can hold a plethora of different securities. You can take your pick from an ETF that can contain bonds, stocks, commodities and different currency types. An ETF is ultimately a basket of different securities that give the trader more liquidity and cost-effectiveness than your average mutual fund.

This cost-effectiveness is most prominent when looking at expensive ratio fees in comparison with a mutual fund but we’ll take a look at the cost advantages of an ETF later. Let’s first take a look at some of the benefits and downsides to trading ETFs.

Low volatility

One of the best things about ETFs, depending on what you are looking for, is the fact that your investment is stable. As you are investing in a number of different securities with your ETF basket as opposed to just one stock. A single stock can take a major downturn in the markets due to a number of external factors like company mismanagement or margin disintegration. Stocks of an entire sector may decline as well but there is a far better chance that while some companies in the sector decline that the competitors pick up the slack and instead prosper. 

Lower fees

Lower fees is just another area where ETFs outshine your average mutual fund. As an ETF is passively managed you will find that they have much lower expense-ratios in comparison to an actively managed mutual fund. There are a number of different expenses that drive the expense ratio of a mutual fund, expenses that an ETF is not as prominently subject to.

While there are a number of positives that make ETFs a fantastic addition to any trading portfolio, there are also a couple of downsides to keep in mind. There aren’t many but they are worth mentioning that you can make your own mind up:

Lower dividend returns

In comparison to an individual stock or a group of stocks, your ETFs are not going to be able to match them for dividend yield. The trade off you see here is a risk vs reward scenario. Your ETFs are safer but because you aren’t taking on as much risk your dividend yield is going to much lower than that of an individual stock. ETFs keep tabs on a broader market which is why you generally see the dividend yield averaging out at a lower amount than an individual stock.  

Potential for higher costs

If you are comparing ETF costs to other funds then it is fair to say that the costs are generally lower which is why we listed it under the benefits. However, if you are comparing ETFs to that of individual stocks then you will find that ETF costs are higher. Your commission on ETF trades won’t vary all that much but the difference comes with the management fee you will pay for an exchange traded fund. Depending on the actual volume of the index, you may find that investing in the actual stocks will save you on costs as opposed to opting for an ETF instead. 

Leveraged ETFs can be risky

When it comes to leveraged ETFs you will quickly come to learn that the risk vs rewards are rather askew. A leveraged ETF is a fund that makes use of financial derivatives to accentuate the returns of an underlying index. If you opt for a leveraged ETF you can potentially lose double or triple the tracked index. If you are going for speculative leveraged ETFs you can take a serious loss if you try to hold your position open for too long. 

On the flip-side of that, a double-leveraged ETF does not necessarily mean that you will see double profits on the underlying index. It is fairly easy to invest in leveraged ETFs so if you are new to the trading world we would advise that you exercise caution here. This is not the way you want to start your ETF trading endeavours.

Before you head straight to our site to get started with your ETF trading, we wanted to give you a few handy tips and tricks to help you on your way. Keep these tips in mind when going forward with your trades:

Avoid trading when the market is volatile

More experienced traders will likely already know this but if you are just starting out with ETF trading then its important to remember that you don’t want to enter the market when it is volatile. Generally speaking, the ETF markets tend to be most volatile in the first and last 15 minutes of the day. In the morning, the prices are still in a “discovery” phase as they are being compared to the previous day’s closing price. The last 15 minutes of the day can see the bigger inventors start to hedge their trades which can influence ETF prices to a significant degree. This will also affect the bid/ask spreads causing them to widen. 

Always watch the bid/ask price

There are always two different prices for an ETF, the price that a trader is willing to sell at (the ask price) and the price that someone is willing to buy at (bid price). The difference between these two prices is called the spread. Always keep an eye on the size of the gap between the two prices. Popular ETFs will generally have a narrower spread while the less popular ETFs will have a wider price spread. Use the underlying market to your advantage as it is the best indicator of these spreads.

Stay on top of political and economic news

Everything from social media posts from prominent political figures to announcements from major corporations can influence ETFs, securities and sectors. More specifically, it can greatly influence the bid/ask spread on your ETFs. This is why it’s best to try and stay abreast of the latest political and economic happenings to either cash in on some momentum or cash out in the wake of a big downturn. 

Stick to the plan

What has happened to the best of traders in the past is that they let their emotions get the best of them. Try to stick to the quantitative analysis and your long term plan instead of letting your “gut” or feelings rule your trading decisions. Always keep the bigger picture in mind as you go forward with your ETF trades.

Now that you know a little bit more about what an ETF actually is and how it can be a beneficial addition to your trading portfolio, you may want to know how you can buy an ETF. It’s an incredibly simple process when you create your nextmarkets account.

That brings us to the end of our guide on ETFs. You should be able to answer the question “what are ETFs?” with a lot more confidence now. ETFs are truly a fantastic way for you to diversify your trading portfolio. The right ETF basket can give you access to tons of different underlying securities and some of the biggest sectors in the world. 

We don’t just teach you about ETFs though as you can also learn how to buy stocks as well. We have got you covered from every angle so that you can improve your overall ability to trade online. You can even learn more about a question that tons of new traders ask themselves “what is short selling?”