State Of The Market: What is an ETF? How to trade ETFs and use them to your advantage
The first time I ever heard the word ‘ETF’ was when a trader was telling me how he generated his biggest loss, shorting one.
When he mentioned the strange acronym I thought of ET: the long-fingered extra-terrestrial that likes to sleep in a basket, riding through the stars.
If Richard Branson and Virgin Galactic could find a way to send people to space on a bicycle, I’d be the first to invest. Emission free space travel, that’s a Press release that would generate interest among day-traders and investors.
But what does ‘ETF’ really stand for? It’s defined as: ‘Exchange Traded Fund’ and you can trade them with a broker, like TradeZero, daily as if it were a stock.
What is an ETF?
There are endless definitions of ETFs on financial websites, such as Seeking Alpha, who describe it as:
…an investment security that combines some of the attributes of stocks and mutual funds. Like stocks, ETFs trade intra-day on an exchange. Like …mutual funds, many ETFs seek to track the performance of a benchmark index, such as the S&P 500.”
My first ETF.
The first ETF I discovered was the $SPY. As a short-seller in my formative years of trading, I grew ashamedly self-obsessed with trying to short the $SPY. I was consistently attempting to predict the next market crash.
To ensure everyone is on the same page, I’ve taken a quick definition of the $SPY, too, from Investopedia:
The SPDR S&P 500 ETF Trust, also known as the SPY ETF, is one of the most popular funds that aims to track the Standard & Poor’s (S&P) 500 Index, which comprises 500 large-cap U.S. stocks. These stocks are selected by a committee based on market size, liquidity, and industry.
The S&P 500 serves as one of the main benchmarks of the U.S. equity market and indicates the financial health and stability of the economy.
“We’ve been in a bull market for what feels like 10 years, it’s got to drop soon”, I’d convince myself.
I’d always forget the golden rule of short-selling: the fact that a stock or ETF being ‘up too much’ is never a good reason to short.
As, the ZeroPro chart of the $SPY ETF shows, this was not the best short from 2020 to 2021. A better approach I later adopted was to wait for the panic.
Once the $SPY fell, hitting year lows in February/March, it brought down several major, blue-chip stocks including : $TSLA, $FB, $AMZN $APPL and $BABA.
These companies seemed to be priced at a major discount despite performing well financially. I bought all at or near lows for what has so far been a successful investment.
In retrospect, why didn’t I invest some money in the $SPY? It would have been safer to dip buy the ETF representing all 500 companies in it as opposed to individual organizations which could be prone to bad news or financials.
The lesson from everything here is, first: be versatile, think long and short. Second: don’t predict anything, just react when it happens.
Looking at other ETFs
The $SPY is actually only one ETF of many, let’s see a few more from Seeking Alpha:
Fixed-Income ETFs: Also known as bond ETFs, these funds track bond market indices, such as the Bloomberg Barclays US Aggregate Bond Index. Other common fixed-income ETF categories include government bond, corporate bond, tax-free municipal bond, international bond, emerging markets bond, and high-yield bond.
Commodity ETFs: Rather than hold the physical asset, which can be inaccessible or impractical for an investor, commodity ETFs track the price of a commodity, such as gold, grains or oil, or a basket of commodities, such as precious metals or agricultural ETFs.
Currency ETFs: As is the case with commodities, currency ETFs provide exposure to currency markets and foreign exchange trading (Forex) that may otherwise be inaccessible to the everyday investor. Currency ETFs may hold cash deposits in the currency being tracked or use futures contracts on the underlying currency.
In an earlier blog we discussed the opportunity that had arisen long and short in the small-cap energy sector, due to the conflict in Ukraine/Russia destabilizing Oil & Gas prices.
Instead of investing/trading tricky, volatile small-cap stocks, such as: $INDO and $IMPP, you could have invested in $USO.
On ZeroPro you can see: this Oil & Gas ETF increased 30%+ across 5 days during the same period the small-cap sector gained momentum.
If you feel more comfortable taking a trade long but want to bet on the $SPY to fall you could consider buying the $GLD ETF which can move up as the $SPY goes down when people move money into a commodity during uncertain times.
Here you can see the ETF steadily climbing to new highs as the $SPY moved to lows during a similar time period.
To wrap it up.
If you’d like to continue the conversation on ETFs, hit me up at Jonk87 on Twitter. I’d love to hear from those that read this blog.