Exchange-Traded Funds

Exchange traded funds (ETFs) are baskets of securities that trade intraday like individual stocks on an exchange and are typically designed to track an underlying index. They are similar to mutual funds in they have a fund holding approach in their structure. That means they have numerous holdings, sort of like a mini portfolio.

Each ETF is usually focused on a specific sector, asset class, or category. ETFs can be used to help diversify your portfolio, or, for the active trader, they can be used to profit from price movements. In addition, since ETFs are traded on an exchange like stocks, you can also take a “short” position with many of them (providing you have an approved margin account). A short position allows you to sell an ETF you don’t actually own in order to profit from downward price movement. Note that shorting a position does expose you to theoretically unlimited risk in the event of upward price movement.

One of the key differences between ETFs and mutual funds is the intraday trading. Mutual funds settle on one price at the end of the trading day, known as the net asset value, or NAV. ETFs are traded on the exchange during the day, so their price fluctuates with the market supply and demand, just like stocks and other intraday traded securities.

Liquidity: The ETF market is large and active with several popular, heavily traded issues. This makes it easier to get in and out of trades. However, liquidity varies greatly, and some narrowly focused ETFs are illiquid.

Choices: There is a huge variety of ETFs to choose from across different asset classes, such as stocks and bonds. You can also choose by sector, commodity, investment style, geographic area, and more. Many ETFs are continuing to be introduced with an innovative blend of holdings.

Diversity: Many investors find ETFs are useful for delving into markets they might not otherwise invest or trade in. Since they are baskets of assets and not individual stocks, ETFs allow for a more diverse approach to investing in these areas, which may help mitigate the risks for many investors.

Commissions and Fees: ETFs typically trade by commission; however PSS offers access to more than 250 commission-free ETFs. In general, an ETF tends to be more cost-efficient than an actively managed mutual fund, because of its indexed nature. This often results in lower fees.

Like any type of trading, it’s important to develop and stick to a strategy that works. Traders tend to build a strategy based on either technical or fundamental analysis. Technical analysis is focused on statistics generated by market activity, such as past prices, volume, and many other variables. Charting and other similar technologies are used. Fundamental analysis focuses on measuring an investment’s value based on economic, financial, and Federal Reserve data. Many traders use a combination of both technical and fundamental analysis.

Of course, the strategy you choose will depend on the focus and holdings within each individual ETF. For example, a corporate bond ETF will depend on fundamental research, such as a company’s credit rating, past and future earnings, as well as the economic outlook for their industry. An ETF that tracks a stock index, for example, will warrant a strategy built on technical data of that index, or fundamental analysis centered on how the stock market may be impacted by the overall economy, or a combination of both.

There are many types of Exchange Traded Funds. Some of the most common ETF include:

Stock ETF – these hold a particular portfolio of equities or stocks and are similar to an index. They can be treated like regular stocks in that they can be sold and purchased for a profit, and are traded on an exchange throughout the trading day.

Index ETF – these mimic a specific index, such as the S&P 500 Index. They can cover specific sectors, specific classes of stocks, or foreign or emerging markets equities.

Bond ETF – an exchange traded fund that is specifically invested in bonds or other fixed-income securities. They may be focused on a particular type of bond or offer a broadly diversified portfolio of bonds of different types and with varying maturity dates.

Commodity ETF – hold physical commodities, such as agricultural goods, natural resources, or precious metals. Some commodity exchange traded funds may hold a combination of investments in a physical commodity along with related equity investments. For example, a gold ETF might have a portfolio that combines holding physical gold with stock shares in gold mining companies.

Currency ETF – these are invested in a single currency or a basket of various currencies and are widely used by investors who wish to gain exposure to the foreign exchange market without directly trading futures or the forex market. These exchange traded funds usually track the most popular international currencies, such as the U.S. dollar, Canadian dollar, Euro, British pound, and Japanese yen.

Inverse ETF – An inverse exchange traded fund is created by using various derivatives to gain profits through short selling when there is a decline in the value of a group of securities or a broad market index.

Actively Managed ETF – these ETFs are being handled by a manager or an investment team who decide the allocation of portfolio assets. Because they are actively managed, they have higher portfolio turnover rates as compared to, for example, index funds.

Leveraged ETF – Exchange traded funds that mostly consist of financial derivatives that offer the ability to leverage investments and thereby potentially amplify gains. These are typically used by traders who are speculators looking to take advantage of short-term trading opportunities in major stock indexes.

Real Estate ETF – These are funds invested in real estate investment trusts (REITs), real estate service firms, real estate development companies, and mortgage-backed securities (MBS). They may also hold actual physical real estate, including anything from undeveloped land to large commercial properties.