What Are ETFs And How to Trade Them

what is an etf

Exchange-traded funds (ETFs) have become extremely popular with traders and investors in recent years for good reason. Simple, transparent, and cost-effective, they offer a straightforward way to gain exposure to a wide range of assets including stocks, bonds, commodities, and real estate.

Interested in learning more about ETFs? This guide to ETFs is a great place to start. In this guide, we’ll walk you through the basics of ETFs and explain how you can invest in them through eToro.

Summary

 

 

What is an ETF?

An ETF, or exchange-traded fund, is a type of investment fund that aims to track the performance of a specific stock market index, industry sector, or asset.

ETFs are in many ways similar to mutual funds. However, unlike mutual funds, they are traded on the stock market. This means that they can be purchased and sold just like regular stocks.

There are ETFs available for virtually every asset class, including stocks, bonds, real estate, and commodities.

Some examples of ETFs include:

To buy or sell an ETF, you need a trading account with a stockbroker or investment platform.

At eToro, buying and selling ETFs is very straightforward. eToro’s platform is easy to use and offers zero commissions* on ETFs as well as low minimum investments.

This means that investing in ETFs is something that anyone can do.

*Zero commission on ETFs is only available to the UK and European clients of eToro UK Ltd. and eToro Europe Ltd. and does not apply to short or leveraged trades.

What are the advantages of ETFs?

There are a number of advantages to investing in ETFs.

These include:

Types of ETFs

There are many types of ETFs available to investors today.

Some of the main types of ETFs include:

How investing in ETFs works

ETF trading and investing are quite simple. Here’s a look at the basics.

Profiting from a rising market

If you believe that a stock market index or asset (such as gold) is likely to rise in the future, you would open a BUY position on an ETF that covers that index or asset. This is called ‘going long.’

For example, if you believe that the S&P 500 index is going to rise over the next year, you would open a BUY position on an ETF such as the SPDR S&P 500 ETF (SPY), which tracks the performance of the S&P 500 index.

If the S&P 500 index does rise, your investment in the SPDR S&P 500 ETF (SPY) will increase in value, and you can close the trade for a profit if you wish. However, if the S&P 500 index falls, the value of your ETF will fall as well, meaning you will generate a loss.

Profiting from a falling market

If you believe that a stock market index or asset is likely to fall in the future, you could open a SELL position on an ETF that covers that index or asset. This is called ‘going short.’

You can open a SELL position on an ETF by trading Contracts For Difference (CFDs). CFDs are financial instruments that offer traders and investors the opportunity to profit from the price movements of a security without actually owning the underlying security.

For example, if you believe that the S&P 500 index is going to fall over the next three months, you could open a SELL position on the SPDR S&P 500 ETF (SPY), which tracks the performance of the S&P 500 index.

If the S&P 500 index does fall, you will profit from your short position. If the S&P 500 index rises, however, you will generate a loss.

 

 

Dividends

A third way you can potentially profit from ETFs is through dividends.

Dividends are cash payments that some companies pay to their investors out of their profits. Not all companies pay dividends but many well-established companies do.

If you hold an ETF that invests in dividend-paying companies, you will receive dividends on a regular basis.

For example, if you hold the iShares FTSE 100 UCITS ETF (ISF.L) – which has exposure to a number of dividend-paying companies listed on the London Stock Exchange – you will receive regular dividends.

ETF fees

There are two types of fees associated with ETFs.

These are:

*Zero commission on ETFs is only available to the UK and European clients of eToro UK Ltd. and eToro Europe Ltd. and does not apply to short or leveraged trades.

Risks of Investing in ETFs

All forms of trading and investing involve some degree of risk and ETF trading and investing is no different.

The main risk that ETF traders and investors face is a market risk or investment risk.

This is the risk that the underlying index or asset falls in value.

If you own an ETF and the underlying index or asset falls, the value of your ETF will also fall.

For example, if you buy an S&P 500 index ETF such as the SPDR S&P 500 ETF (SPY), and the S&P 500 index falls 20%, the value of your investment is also likely to fall by around 20%.

Similarly, if you buy a gold ETF such as the SPDR Gold ETF (GLD) and the price of gold falls 20%, the value of your investment will also fall by about 20%.

It’s important to note that leveraged ETFs carry additional investment risk.

For example, if you buy a leveraged ETF that offers 2x the exposure to the S&P 500 index and the S&P 500 falls 10%, you are looking at a loss of 20% instead of 10%.

Risk management strategies

You can never eliminate risk completely when investing in ETFs, however, there are ways to reduce risk.

One of the most effective ways to reduce risk is to diversify your portfolio. This means spreading your money out over many different investment assets so that you’re not over-exposed to any single asset. A diversified portfolio might have exposure to equity ETFs, bond ETFs, and commodity ETFs.

For stock index ETFs, adopting a long-term investment horizon is another strategy that can help reduce the risk of losing money. In the short term, stocks can be highly volatile. However, in the long run, the stock market tends to rise. So, generally speaking, the longer you invest, the less chance you have of losing money.

For short ETF trades, stop losses can also be an effective risk-management tool. Stop losses help minimize investing losses by closing out losing positions before large losses build up.

 

 

How to Choose an ETF

There are hundreds of ETFs available to investors today.

When it comes to choosing an ETF, the first thing to do is to define your goals and objectives, and your risk tolerance.

Common goals and objectives include:

Once you have determined your goals and objectives, you can identify an ETF that can help you achieve them and is suited to your risk tolerance.

With hundreds of ETFs to choose from on eToro, including stock index ETFs, sector ETFs, commodity ETFs, and inverse ETFs, you’ll find one that matches your requirements.

You can check out the full range of ETFs eToro offers at the etoro.com ETF page.

How to trade ETFs on eToro

ETF trading and investing are straightforward on eToro.

Here’s how to place a trade:

  1. Log in or create an online trading account by going to www.etoro.com
  2. Head to our Markets page, and then select ETFs to access the full list of ETFs that are available to trade
  3. Select the ETF that you wish to trade, then select Trade
  4. Select BUY or SELL depending on the direction you wish to trade
  5. Enter the amount of money you wish to trade or invest or the number of units of the ETF you wish to buy or sell
  6. If going short, set a stop loss
  7. Select Open Trade

 

Glossary

 

 

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money

This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to buy or sell, any financial instruments. This material has been prepared without having regard to any particular investment objectives or financial situation, and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.

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