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Let's start off with the basics of what ETFs are all about:
ETF Advantages:
- No risk of significant overnight gaps, since ETFs seldom gap more than 1-3 points overnight from day to day.
- Simplifies scanning workload, compared to trading individual stocks.
- Can trade within specific sectors (like FAZ for 3x financial), in addition to broad market ETFs like the SPY/QQQQ. This is good because you may want to concentrate on trading activity within a specific area, without having to also scan for and trade from among all stocks in a sector.
- The short ETFs (like SDS/SMN/FAZ/VXX) let you participate in market downturns without having to actually short stocks, since these go up when the market goes down.
- Avoid costs associated with mutual funds, for longer-term positions.
- ETFs typically have very well-defined average daily trading ranges, making both pivot and breakout trading styles easy to use since the day-to-day variation in trading ranges is relatively constant.
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Here's a snapshot of a quotebox (sorted in alphabetical order) of some popular
ETFs that are ideal for active traders. Note that some are the exact inverse/opposite
of each other (so their charts look like mirror images of each other), like FAZ vs FAS:
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ETF Definitions
What are
Exchange-Traded Funds (ETFs)?
An exchange-traded fund (ETF) is basically an investment fund that's traded in the same way stocks are, which allows traders to actively trade what's in essence a group of stocks bundled together in a single ETF stock.
Their chart patterns and movements track the same way regular stocks do, and most are priced $10-$70/share. One advantage to trading ETFs is that they don't have large gaps, with most having gap risk of no more than 1-3 points from day to day.
They also allow traders to avoid the challenge involved in daily or weekly individual stock-picking, since trading ETFs is similar to trading an index itself, as the ETFs track sectors, indices and other groups of tradable instruments.
For those who trade both ETFs and stocks, they are important to understand because they can give an early 'lead indicator' for market pivots and breakouts, especially with leveraged ETFs like FAS/FAX and others.
Major Types of ETFs for Active Traders:
Index ETFs:
Index ETFs like the SPY, QQQQ, DIA and IWM hold securities and reflect the movement of the underlying index for which they're named. If you pull up the chart for QQQQ as well as the NASDAQ Composite for example, you'll see that the chart pattern looks fairly identical.
These ETFs try to have a representative sample of stocks that capture moves that are shown in the underlying index, and are best used in trading as indicators for long/short market bias, pivot points, breakouts and more. Active traders can use these in combination with realtime market indicators like the VIX and TRIN to determine long/short bias.
Sector ETFs:
Sector ETFs (like the DRN, real estate long) are focused on specific sectors such as oil, real estate, financial sector and others. They provide the trader with a good opportunity to trade specific relative-strength breakouts for sectors that are outpacing the broad market on a day-to-day basis.
(
for more on sector ETFs, see this NASDAQ article)
Leveraged ETFs:
Leveraged ETFs like the FAZ (Direxion daily financial bear 3x) are especially popular with day traders, because of their increased volatility. They are also riskier to trade, and are best traded by experienced traders. Leveraged ETFs are more sensitive to market moves and "magnify" the bullish/bearish breakouts and pivots compared to unleveraged ETFs.
Commodity ETFs:
The commodity ETFs trade commodities such as metals and futures, such as oil, gold, livestock and others. For example, the GLD ETF provides a way to invest or trade in gold (as a position hedge, or for active day and swing trading). Many of the "direct commodity ETFs" are actually structured as exchange traded notes (ETNs) as they trade the futures contracts on the underlying commodities.
Currency ETFs:
These ETFs seek to provide a way to trade movements in specific currencies, like the Rydex FXE (Euro Currency Trust) and others. These provide an alternate way to trade the strength or weakness of specific currencies without the need to trade the spot forex market.
Additional Resources:
For additional ETF definitions, ETFPlays recommends these excellent articles:
Wikipedia: Exchange-traded fund
and
Investopedia: Exchange-Traded Fund
as well as our premium home study DVD course with ETF webinars:
ETFMastery.com: ETF active trading course
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