ETF Trading |
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When it comes to trading and investing, like most ventures, information is power. It is best to understand what tools are available and potentially useful to you. An exchanged-traded fund (ETF) can be a very useful trading tool but must be used the right way to be effective. This article is meant introduce you to the capabilities of ETFs and how to get started trading them. We will zoom in on two ETFs, Proshares Ultra S&P500 (SSO) and Proshares Ultrashort S&P500 (SDS), which we trade in the TSP Talk Plus system. However, keep in mind that these are just two of many different types of ETFs. The Intrepid Timer premium service primarily trades the more aggressive Proshares UPRO and SPXU, as well as the iShares TLT bond ETF.
What is an ETF?
ETFs are marketable securities that are publicly traded in the stock exchange and bond exchange. The price of the ETF changes throughout the day and can be quickly converted into cash. Most commonly, ETFs are composed in order to trade in tandem with entire indices or sectors. For example, creators of an ETF that follows the trading action of the S&P 500 will purchase a pool of stock shares within the index and group them into a single share of the ETF. Technically this ETF can be exchanged for the original pool of shares it represents. The buyer of the ETF can trade the share for the actual stocks shares it represents or sell the share of the ETF in the open market for the same value. Essentially ETFs are a trading tool that allow investors to diversify entire sectors with just one investment.
The goal of an ETF is not always to match the return rate of the sector it follows. Leveraged ETF attempt to magnify the daily return of the shares it follows most commonly by 2 or 3 times. Traders use these funds in attempt to magnify their returns during short-term momentum or to reach a target level of exposure for less cash. Leveraged ETFs come with greater risk and are not meant for long term investments as they naturally depreciate overtime when their target sector’s price fluctuates.
Examples of leveraged ETFs are Proshares Ultra S&P500 (SSO) and Proshares Ultrashort S&P500 (SDS). Both ETFs trade double the daily return of the S&P 500 but each in opposite directions. A 1% gain in a single day for the S&P 500 will result in a gain of 2% in SSO and a loss of 2% SDS. It is important to note again that in a volatile market both leveraged ETFs will lose value over time and are not meant to buy and hold. We use these leveraged ETFs in TSP Talk Plus System moving between these two ETFs and a cash position in attempt to time swings in the market and maximize returns. As mentioned previously, the Intrepid Timer premium service primarily trades TLT, UPRO, and SPXU. TLT is a Bond ETF, and the other two are triple leveraged S&P 500 ETFs.
SSO
The ETF Proshares Ultra S&P500 (SSO) attempts to double the daily return of the S&P 500. Traders feeling bullish will use this ETF to potentially magnify short-term gains. It also comes with the risk of magnified losses if the S&P 500 were to lose value for the day. This allows traders to reach a target level of exposure for less cash.
Again, it is the daily return of the S&P 500 that SSO seeks to double. Day to day volatility in the S&P 500 index price will close the gap between the index and SSO gains in a bull market and further magnify losses in a bear market over time. This natural depreciation of the leveraged ETF makes it a poor long-term investment. Investors who wish to use this trading tool should be mindful of this and shoot to buy and sell SSO in short-term periods.
SDS
The ETF Proshares Ultrashort S&P500 (SDS) attempts to double the inverse daily return of the S&P 500. Traders feeling bearish will use this ETF to profit from declines in the S&P 500. It is also a tool to hedge against market sell-offs.
The long-term return between SDS and the S&P 500 works just as mentioned with SSO. Since the end of the bear market in 2009, SDS has fallen more than double the return of the S&P 500 due to the natural depreciation of leveraged ETFs in volatile markets. This makes SDS a very poor long-term investment and should be traded in short-term periods for the best returns.
Using ETFs
So how can we use these ETFs like SSO and SDS effectively? A very simple trading strategy would be to jump between SSO, SDS, and a cash position. A cash position simply means you are not holding onto shares of an ETF and have full purchasing power in your brokerage account. This is an attempt to time the market. A trader’s goal is to either buy SSO shares during bullish swings in the S&P 500 or buy SDS during bearish swings in the S&P 500 or sell their shares and hold a cash position during more volatile or uncertain market conditions. Because of the risk that comes with holding a leveraged ETF it is necessary for investors to keep a close eye on their investments and attempt to limit their exposure.
Where to Trade
An online broker is needed to trade ETFs. There are several options that depend solely on the investors needs and size of trading account. I personally use Robinhood Financial because there are no trading fees, no account minimum, and the app is simple to use. I recommend Robinhood for anyone who is a complete beginner at trading ETFs. I still encourage you to do your own research. NerdWallet has a great blog where they evaluated the strengths and weaknesses of the major online brokers. Poke around and find what best fits you.
Thanks for reading. I hope this page was helpful.
TommyIV
Disclaimer: ETF trading involves risk, including the possible loss of principal, and is not suitable for all investors.
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