What Are ETFs And Why We Trade Them
Hello traders, welcome to the stock-trading course and the fifth module: day trading ETFs.
In this lesson we are going to define what ETFs are and why we trade them. So let’s start by defining what an ETF is. An ETF or ETF stands for Exchange Traded Fund. An ETF is a security that tracks an indexed, a commodity, currencies, bonds, or a basket of assets, such as index funds. And ETFs allow you to purchase a broad basket of securities in one single transaction if we are talking about an ETF that tracks a basket of assets.
They offer the convenience of a stock with the diversification of a mutual fund. The purpose of an ETF is to track the underlying bundle of securities which usually represent a particular index or a sector of the economy. So if you want to trade or if you want to invest in an index fund or if you want to invest in a commodity, but you have limited buying power, you can invest in such commodities through ETFs. Or if you want to invest in more complex products or a sector of the economy, like small tech companies, you can invest in them through ETFs.
So why do we trade ETFs? That’s easy. The low cost. ETFs usually track the underlying asset at around 10% of the price basis. For example, the SAP 500 is at $2,033.11 and the spy, which is the spider SAP 500 ETF trust is at $203.27. Now, I’m going to show you the SAP 500 chart. This is the daily SAP 500 chart. You can see that today it closed at $2,033.11. This is the spy chart, which is the ETF that tracks the SAP 500. You can see that both charts are very similar. It closed at $203.27.
So basically if you have limited buying power, you can invest in indexes by only putting 10% of its value. The other reason is the liquidity. ETFs are the most liquid security from the stock exchange. Because of the massive volume in them, you are going to have immediate execution and practically no slippage. Now here is the Finviz stock screener. And I have only future in the average volume of one million and the current volume of five million.
And you can see that the number two stock is the spy, which is the spider SAP 500 ETF trust, which traded 112 million shares. And then you have other ETFs that traded between 59 and 65 million shares. You have emerging markets, the big gold miners, etc. So you can see that ETFs actually have the biggest volume on the stock exchange.
And the last reason is immediate diversification. For example, if you think that investing in emerging markets is a smart move, but don’t know where to start, you can buy EEM which is the iShares MSCI emerging markets ETF.