ETF – Exchange Traded Funds trading
The place to LEARN all about investing in ETFs
What is an ETF?
ETFs or Exchange Traded Funds, are baskets of securities (can be any securities), bundled up into stocks that trade on an exchange.
ETFs are a type of investment fund that combines the advantage of redeemable units of open-end funds, with the advantage of trading throughout the day on an exchange, of a closed-end fund. An ETF portfolio can hold stocks, bonds, commodities, or a combination of all, and mostly replicates the performance of a specific index, sector, or commodity.
How are ETFs performing today
courtesy of TradingView
Exchange traded funds (ETFs) came a long way since 1993, when the most popular ETF called SPDR S&P 500 ETF (SPY) came to life, that aimed to track the S&P500, all thanks to Nathan Most who was accredited with its design.
The early days of ETFs had their ups and downs, but came to be a very sought after investment product for diversification, low cost and broad exposure to an array of markets.
Various types of ETFs are available to trade, with different levels of risk, so a solid understanding of what they are, what goal they are looking to achieve and the model they follow needs to be in place.
ETFs at a glance
Managed by registered professionals
Priced throughout the day
Pools funds from many investors
Trades on an exchange like stocks
Creation and redemption mechanism
Active Vs Passive ETFs
Its important to differentiate between passive and active ETFs. Most of them track the performance of an index or an underlying group of investments, with no need of active management of the funds (also known as passive funds), while others attempt to outperform the markets with a more active approach (known as active funds).
Passive funds assign weights the same way the underlying index does. Active funds assign weights at will (overweight or underweight the securities in the index), in an attempt to outperform.
Active fund management can incur higher costs to cover the portfolio manager. Its important to distinguish between outperformers and underperformers if opting for the active funds, since most underperform the market once fees and costs are accounted for. A low-cost passive ETF might be the better choice, if there’s no constant outperformance.
Types of ETFs
There are thousands of ETFs available and since they don’t only track indices but also sectors, economies and an array of asset classes, the diversification potential is immense.
The three largest ETF providers, own 75% of the market share
here are their examples that track the S&P 500 Index
Blackrock
Symbol: IVV
Inception Date: May 15, 2000
Vanguard
Symbol: VOO
Inception Date: September 07, 2010
State Street Global Advisors
Symbol: SPY
Inception Date: January 22, 1993
Blackrock
Vanguard
State Street
iShares is the ETF brand of Blackrock and the world’s largest ETF provider wth over 400 ETFs under its belt. Blackrock holds 33% of the US market share.
Vanguard is the second largest ETF provider worldwide and offers equity and fixed income ETFs since 2001. Vanguard holds 29% of the US market share.
State Street Global Advisors created the first ETF (the SPDR) in 1993 and is the 3rd largest ETF provider. State Street holds 14% of the US market share.
The mechanics of an ETF
from concept and creation, to the portfolio of the end investor
It’s important to distinguish certain players within the ETF flow. The process is easy to follow, once we place the correct player in the correct position. Some players can hold two positions i.e market makers and authorized participants, or some players might be known by many names i.e. broker/dealer, market maker, liquidity provider, execution venue – so placing them correctly (see images below) is the first step.
Exchange Traded Funds trade on stock exchanges like publicly listed company stocks. But, where company stocks have a capped supply with big demand/supply shocks affecting their price, ETFs follow a creation/redemption process that adds or removes stocks from circulation.
All players contribute, from the end buyers and sellers, all the way up the ladder to the ETF issuers like Vanguard, State Street and iShares.
On creation
The authorized participant, can either:
- buy and deliver the basket of securities to ETF issuer or
- pay the cash value of the basket (plus the purchase cost)
On redemption
The ETF issuer can either:
- deliver the basket of securities to the authorized participant or
- pay the cash value of the basket (plus any costs)
Thinking of trading ETFs?
ETFs can be traded directly through a brokerage account, just like stocks. The broker will list all relevant information related to the fund (factsheet), like expense ratios, assets under management, holdings, dividends (if applicable), YTD return, the current price, the NAV to name a few.
ETFs can also be traded through derivatives such as futures and options. These are standardized contracts on the underlying ETFs and they also require opening a brokerage account with an investment broker. Other ETF derivatives include CFDs.
What type of investor are you? Do you have strong risk tolerance? Will you be actively or passively investing? Are you looking for diversification? Will you be targeting a specific sector or income generation?
Once your investment goals are defined, you start looking into the fund's performance, the underlying index, the ETF's structure, expense ratios, tracking errors and liquidity, and of course when and how you can trade it.
Even experienced traders need guidance sometimes. But especially new investors need to find their investing identity and exchanging views with knowledgeable parties, can help you anticipate the unimaginable
Factors that affect ETF prices
ETF values can be affected by all the reasons that affect their holdings. At the same time, since Exchange Traded Funds trade like stocks, supply and demand are always the main price drivers.
National policies, global relationships
Changes to the composition of the ETF
Economy and fundamental indicators
Commodity price fluctuations
Company fundamentals, earnings reports
Volume, liquidity, buy/sell pressures
Natural disasters, disease, pandemics
Especially multinational companies
Is ETF trading a new language for you? Visit our database with basic and advanced definitions
How to trade ETFs?
What are ETFs, their structure, trading hours, CFDs
Symbols, bid/ask, pips, spread, price movers
Margin, margin call, stop out, leverage, lots, rollovers
Stop loss, trailing stop, take profit, pending orders
Fundamental, technical, sentimental analysis
Trader types, risk tolerance, start small, pick direction, test
Strict selection process, open a/c, KYC, funding, trade
Trading log, review, evolve, socialize, use technology
Start with demo accounts, move to live but small
Profitability, how to choose a broker, what to trade?
A closer look to ETF pros and cons
ETF is the mutual fund’s friend with benefits
How do they compare?
Did you know?
That ETFs are part of a larger group of investment products called ETPs (or Exchange Traded Products)?
ETFs are ETPs but not all ETPs are ETFs. Confused?
Securities listed on an exchange, with intraday trading similar to stocks. The category contains all similar products like traditional ETFs, Commodity ETPs, Currency ETPs, Crypto Asset ETPs and Exchange Traded Notes (ETNs). Some ETPs are registered as investment companies, while others are not raising their risk level (example ETNs).
Securities listed on an exchange, with intraday trading similar to stocks. ETNs are not basket products and don’t hold shares of the underlying assets they track. ETNs are unsecured debt obligations, issued by large banks or financial institutions. Credit rating of issuer is important, because with no assets held, there is no other backup.
Securities listed on an exchange, with intraday trading similar to stocks. These are products invested in either physical commodities, or futures commodities contracts. ETFs require minimum level of diversification, so if investors want to invest in a fund that tracks a single commodity, they would look into a commodity ETP also known as ETC.
Securities listed on an exchange, with intraday trading similar to stocks. These are products invested in foreign exchange either to currency pairs (majors) or baskets of currencies. They are backed by deposits in a bank that holds the foreign currency. They typically track forward indices and they are extremely speculative and risky products.
Securities listed on an exchange, with intraday trading similar to stocks. Bitcoin and ether futures ETF are products invested in futures contracts of the underlying crypto, approved by the CFTC in October 2021. Spot Bitcoin ETF tracks Bitcoin’s spot price by holding a large amount of the cryptocurrency itself and was approved in January 2024.
ETF FAQs
What is an ETF?
ETFs or Exchange Traded Funds, are baskets of securities, bundled up into stocks that trade on an exchange.
Is ETF trading good for beginners?
Every investor started as a beginner. All traded products are complex financial instruments and require special attention. ETF trading is relatively inexpensive, there is an array of options (thousands of ETFs in available), and due to their basket nature, they can be shock absorbers against individual securities trading.
Are all ETPs also ETFs?
All ETFs are also ETPs, but not all ETPs are ETFs. ETPs or Exchange Traded Products include other instruments like ETNs (exchange traded notes), ETCs (exchange traded commodities), Currency ETPs and Crypto ETPs.
Is ETF trading a good investment?
There are many advantages to seriously considering looking into ETF trading as an investment. Low operational costs, flexibility, tradability through an exchange, diversification, transparency. As with all investments, due diligence and research is required to find how ETF trading can be positioned in the portfolio.
Research and education is key
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