ETF trading and investment strategies

What is an ETF?

An exchange traded fund (ETF) is a basket of securities that trades on an exchange similarly to stocks. An ETF is a fund that can hold multiple underlying assets, rather than only one like a stock does. This makes it a popular choice for diversification.

An ETF can include shares, bonds, commodities and forex, to name a few. ETFs will often track an index fund as a marker of performance.

How does investing in an ETF work?

Like with stock investing, ETF investing involves taking a longer view toward income generation. Because there is a wide range of ETFs to invest in, you must do your due diligence and consider both your timeframe and favourite sectors.

For example, you might want to have an ETF with stocks in several regions to account for geographical volatility, or invest in both the dollar and tech stocks to try and balance out economic shocks.

You can invest in ETFs on our share trading platform - investing in international ETFs is commission-free with us if you opt for the default setting of 'instant currency conversion'.*

You could use dollar-cost averaging to spread your investments out over a period of time, or lump-sum investing, depending on your long-term ETF strategy.

*See our full list of share trading charges and fees.

How does trading an ETF work?

Much like with trading on and investing in stocks, an ETF strategy can have a short or long-term focus. However, trading is typically more suitable the short term.

Traders can go long or short on ETFs throughout the day, just like any stock. You can use technical analysis tools to try and identify entry and exit points for buying and selling an ETF.

Positions on an ETFs are opened throughout the day based on news or wider market factors that push its resistance and support levels - which can affect supply and demand for that ETF. This price continually changes during trading hours, providing opportunities for profit, but there's also potential for loss.

Traders can get price quotes at any time during market opening hours. With expertise, sophisticated strategies like swing trading and sector rotation can also be employed.

ETF investing strategies

ETF investing strategies include:

Dollar-cost averaging

Dollar-cost averaging is the technique of buying a set fixed-dollar amount of an asset on a regular schedule, regardless of the changing cost of the asset.

The idea behind dollar cost averaging is that an investor may compensate for the volatility inherent in ETFs and take advantage of short-term price movements that might prove more valuable than investing in one go.

Say you invest $2,400 in an ETF in a lump sum in January. At the end of the year, the ETF has grown 6%, so your investment is now worth $2,544. Or, imagine you invest $200 each month of the year. The ETF may see a sharp decline of 20% at the start of the year before gradually ascending through the rest of the year. Your investment could be worth more than it would have with the lump sum put in at the start of the year, were this scenario to occur. However losses could occur at another point or in a different way to make dollar-cost averaging less profitable.

Such investors may take a few hundred dollars every month and, instead of placing them into a low-interest saving account, invest them in an ETF or a group of ETFs.

Asset allocation

Asset allocation, ie how you divide assets across broad asset classes, is a key driver of a portfolio's risk and return.

The low investment threshold for most ETFs makes it less complicated for a beginner to implement a basic asset allocation strategy, depending on their investment time horizon and risk tolerance.

Buy and hold

For this strategy, you purchase an ETF that is diversified across multiple asset classes. Then, you use dollar-cost averaging or lump sum investing to continue topping it up on a regular basis.

When buying and holding, some investors consider funds with lower expense ratios.

ETF trading strategies

ETF trading strategies include:

Trend following

Trend following is one way to trade on ETFs. It involves buying an ETF at the beginning of its upward trend or shorting it at the beginning of its downward trend. One way this can be done is through classic technical analysis tools like moving averages to gauge the ETF's resistance and support lines.

Day trading

Day trading refers to the buying and selling of ETFs in a single trading day. Some popular ETFs for day trading are:

• SPDR S&P 500 (SPY)
• Gold Miners ETF (GDX)
• ProShares VIX Short-Term Futures ETF
• ProShares Ultra VIX Short-Term Futures ETF (UVXY)
• iShares MSCI Emerging Markets ETF (EEM)

Day trading an ETF can provide you with short-term opportunities, but they can also be rather risky due to the use of leverage in derivative products, making it important to manage your risk accordingly.

With the complexity and risk involved, it's important to be able to distinguish between leveraged ETFs - that are ETFs that utilise leverage within the funds investments - and non-leveraged ETFs. You'll trade all ETFs on our platform using contracts for difference (CFDs), which are leveraged derivatives.

Taking a positionx on seasonal trends

Like most assets, ETFs can be subject to seasonal shocks, depending on the assets that make up the fund.

Some months – typically September and October – tend to perform well for commodities such as gold because of strong demand from India ahead of wedding season and the Diwali Festival of Lights. Oil and natural gas, meanwhile, can experience a spike during cold winters in Europe and Asia when there is increased demand for energy to heat homes and buildings.

Another way of taking a posirtion on trends is through the 'sell in May and go away' theory. This refers to US equities, which have historically tended to underperform over the six-month May–October period, compared with the November–April period.

Taking a position on seasonal trends is risky. This is why stop losses can be useful in managing risk. However, even with a stop-loss, there is the chance of slippage risk which can amplify losses.

Hedging

ETFs offer beginners an efficient method of hedging that can protect against downside risk in a substantial portfolio.

Suppose you have inherited a sizeable portfolio of US blue chips and are concerned about the risk of a large decline in US equities. One potential approach is to short stocks using a leveraged derivative like a CFD. Some traders initiate short positions in ETFs like the SPDR S&P 500 ETF or the SPDR Dow Jones Industrial Average ETF (DIA).

If the market declines as expected, your blue-chip equity position will be hedged effectively. That's because the declines in your portfolio will be offset by gains in the short ETF position.

What to consider when trading or investing in an ETF

Check the ETF's track record

Review an ETF’s past returns over different time periods to understand how it has performed in various market conditions. However this should be treated with caution as past performance is not guarantee of future performance.

Has an ETF succeeded in gathering assets?

The size of an ETF's asset base can provide insights into its popularity among investors. A larger asset base often indicates greater liquidity and stability, as well as the potential for lower expenses.

Is there reasonable trading volume?

Adequate trading volume ensures that you can easily buy or sell shares of the ETF without significantly impacting the market price. Low trading volume may result in wider bid-ask spreads and increased transaction costs.

Does the performance of an index ETF closely match the index it's aiming to track?

For index-based ETFs, it's important to evaluate how closely the ETF's performance aligns with the underlying index it seeks to replicate. Tracking error, or the deviation from the index's returns, should be minimal for an effective index ETF.

What are the tax implications of the ETF, including its turnover rate and potential capital gains distributions?

Consider factors such as the ETF's turnover rate, which indicates the frequency of buying and selling securities within the fund. Higher turnover rates can lead to increased capital gains distributions, potentially resulting in tax consequences for investors.

How well-diversified is the ETF?

Assess the holdings of the ETF to ensure it provides exposure to a broad range of assets or sectors, reducing the risk associated with individual stocks or industries.

Think about the companies behind the ETF and their record financially as well as with regulators

Research the companies managing the ETF, including their financial stability and track record on earnings and dividends. Additionally, consider their adherence to regulatory requirements, which ensures transparency and investor protection.

Consider costs like expense ratios

ETFs have expense ratios, which represent the annual fees charged by the fund for managing and operating the ETF. Lower expense ratios are generally preferable as they can have a significant impact on long-term returns.

Trading risks

While traders and investors like ETFs for their diversification, there are still risks to consider when trading them. ETFs are prone to the same market and political risks as individual securities. It's important to consider these and regularly check in on the securities within your preferred ETF.

Consider the Target Market Determination

ETF issuers are required to publish a Target Market Determination (TMD) for every ETF listed on an Australian exchange. The TMD sets out the class of consumers for whom the ETF – including its key attributes – would likely be suitable for based on their objectives, financial situation, and needs.

Most ETFs distributed by us have been categorised by issuers (such as BetaShares and Vanguard) as investments that are suitable for consumers who have a high (or very high) ability to bear loss. This consumer risk and return profile focuses on an investor’s objectives for the relevant portion of their portfolio only, and not the investor’s portfolio as a whole.

Before you invest in an ETF, it’s important to consider the relevant TMD available from the ETF issuer to determine whether the ETF is consistent with your objective, financial situations and needs.

How to invest in ETFs

1. Create your live account with us
2. Choose our share trading account
3. Research your opportunity and manage your risk
4. Fund your account
5. Open your position and monitor your investment

When share trading, you buy and hold the shares. You can earn a passive income through being a shareholder of a dividend-paying ETF - you can make a profit if the share price rises, and you sell your shares at a price higher than the original buy price. The maximum possible loss you're exposed to is equal to your upfront investment, in the case of delisting or the share price dropping to zero, excluding and additional fees.

How to trade on ETFs

1. Research your preferred market
2. Decide what you want to trade on
3. Open a live account or practise using a demo account
4. Select your opportunity
5. Set your position size, manage your risk and place your deal
6. Monitor your trade

Remember, trading with CFDs comes with added complexity and risk attached to leverage. Your position will be opened at a fraction of the value of the total position size – but you can gain or lose money much faster than you might expect. You can even lose more than the deposit paid to open the position, as your potential profits and losses are magnified to the full size of the trade.

Learn about the differences between trading and investing in shares and ETFs.

ETF strategies summed up

• An exchange traded fund (ETF) is a basket of securities that can be traded on an exchange in the same way as stocks
• You can trade on ETFs by going long if you're bullish, or going short if you're bearish
• Trend following, swing trading, day trading and taking a position on seasonal trends are a few ways you can trade on ETFs for a short-term strategy
• Dollar-cost averaging, asset allocation and buy and hold are a few strategies used by investors for a longer-term ETF strategy
• When trading or investing in ETFs, you should consider past performance, its volume, its performance against a tracked index and how well-diversified the ETF is, but remember past performance doesn't guarantee future returns