05/04/2011
No matter how much of an expert you’ve become in a particular field, it’s always a good idea to step back and review. When it comes to investing with exchange-traded funds (ETFs), there are several basic "rules" I like to periodically visit.
As you likely know, I’ve been touting ETFs as excellent investment growth vehicles, but anything that is new to you can be a little tricky. So, here’s a brief review of some of the basics to keep in mind when investing in ETFs.
ETFs are flexible investments -- you can buy options, go short, and hedge. ETFs also let you invest in a variety of sectors and trends without the risk of single-stock exposure. In fact, some international ETFs give you exposure to stocks or entire sectors that can't be bought in U.S markets. Let's face it, ETFs offer diversity -- if your goal is to have a mix of assets, ETFs let you do this simply and cheaply.
Remember, just because ETFs have stock-like properties doesn't mean that you are confined to investing in equities. ETFs let you bet on almost anything that can be tracked by an index. Since the economic downturn, it has become wise to look into alternatives to stocks, namely bonds and currencies. Through ETFs, you can focus on corporate bond indices and/or inflation-protected Treasuries. You can buy ETFs that short the British pound sterling, are bullish on the Japanese yen, etc. There are even ETFs out there that let you buy a basket of currencies ranging from the Indian rupee to the Swedish kroner.
Another alternative to stocks could be to keep part of your portfolio in cash. Instead of using money market funds, you could invest in short-term bond ETFs, which often pay double or triple what money market funds yield.
I like to isolate trends in the market by observing both the 50- and 200-day moving averages to know when to buy and sell. The moving averages remove the "noise" in stock prices. When a stock breaks above or below its 50-day average, the short-term trend has been broken. When the ETF falls below its 200-day average, it is time to sell.
This rule is more technical than strategic. To lock in your profits and limit losses, you must set reasonable stop prices or trailing stop losses, depending on the pick. If you have a trailing stop loss in place, you will be protected if the price of your ETF soars and then suddenly dives.
Another important thing to remember while trading ETFs is to watch for trading volume. You want to invest only in ETFs that have a daily trading volume of at least 100,000 shares. Remember, the higher the volume, the more liquid the ETF. A fund with low trading volume could leave you vulnerable to wider swings in the share price during volatile times.
Of course, there certainly is more to know about ETFs, but you now have some basic rules to follow. It never hurts to remember the fundamentals of ETF investing, whether you are an experienced investor or just trying to get started. In a volatile market, knowledge and caution gain heightened value.
If you want my advice about buying and selling specific ETFs, including appropriate stop losses, please sign up for my ETF Trader service. As always, I am happy to answer your questions about ETFs, so do not hesitate to email me by clicking here. You may see your question answered in a future ETF Talk.