Because of their numerous advantages, exchange traded funds (ETFs) are perfect for new investors. These advantages include low expense ratios, extensive liquidity, a wide variety of investment options, diversification, a low investment threshold, and so on. These characteristics also make ETFs ideal vehicles for different trading and investing methods used by novice traders and investors. The seven finest ETF trading methods for beginners are listed here in no particular order.
- ETFs, which combine broad indexes or sectors into a single investment, are becoming more popular among traders and investors.
- ETFs are also available for a variety of asset classes, either as leveraged investments that return a multiple of the underlying index or as inverse ETFs that rise in value when the index falls.
- Several tactics may be employed to optimize ETF investment due to their distinct character.
1. Dollar-Cost Averaging
We’ll start with the most fundamental strategy: dollar-cost averaging. Dollar-cost averaging is the practice of purchasing a fixed-dollar quantity of an asset on a regular basis, regardless of the item’s fluctuating cost. Beginner investors are often young adults who have been working for a year or two and have a steady salary from which they can save a little each month.
Such investors could set aside a few hundred dollars each month and put it in an ETF or a collection of ETFs rather than a low-interest savings account.
For novices, there are two significant benefits to investing on a regular basis. The first is that it makes saving more disciplined. It makes perfect sense, as many financial advisers advise, to pay yourself first, which you can do by saving consistently.
The second benefit is that by investing the same fixed-dollar amount in an ETF every month—the fundamental principle of dollar-cost averaging—you will acquire more units when the ETF price is low and fewer units when the ETF price is high, so average out the cost of your holdings. As long as the discipline is maintained, this technique may pay off handsomely over time.
Assume you invested $500 on the first of every month from September 2012 to August 2015 in the SPDR S&P 500 ETF (SPY), which follows the S&P 500 Index. Thus, in September 2012, when the SPY units were trading at $136.16, $500 would have gotten you 3.67 units, but three years later, when the units were trading close to $200, $500 would have gotten you 2.53 units.
Over the course of three years, you would have acquired a total of 103.79 SPY units (based on closing prices adjusted for dividends and splits).These units would have been worth $21,735, based on the closing price of $209.42 on August 14, 2015, for an annual return of over 13%.
2. Asset Allocation
Asset allocation, or assigning a percentage of a portfolio to multiple asset categories for diversity (such as stocks, bonds, commodities, and cash), is a significant financial strategy. Because most ETFs have a modest investment barrier, a novice may easily apply a basic asset allocation plan, based on their investing time horizon and risk tolerance.
Because of their extended investing time horizons and high risk tolerance, young investors in their 20s may be completely engaged in equities ETFs. However, once they enter their 30s and begin significant lifecycle transitions like as raising a family and purchasing a home, they may move to a less aggressive investing mix, such as 60% in stocks ETFs and 40% in bond ETFs.
3. Swing Trading
Swing trades are transactions that aim to profit from large fluctuations in stocks or other assets such as currencies or commodities. In contrast to day transactions, which are seldom kept open overnight, they may take anything from a few days to a few weeks to sort out.
Diversification and narrow bid/ask spreads are two characteristics of ETFs that make them appropriate for swing trading. Furthermore, since ETFs are accessible for a broad variety of investment classes and sectors, a newbie might select to trade an ETF based on a sector or asset class in which they have special skill or understanding.
Someone with a technical background, for example, may have an edge when trading a technology ETF such as the Invesco QQQ ETF (QQQ), which follows the Nasdaq-100 Index. A new trader who is interested in commodities markets may want to trade one of the various commodity ETFs available, such as the Invesco DB Commodity Index Tracking Fund (DBC).
Because ETFs are often baskets of stocks or other assets, they may not see the same level of price movement as a single stock during a bull market. By the same token, their diversity makes them less vulnerable to a large negative fall than single equities. This protects against capital degradation, which is a significant issue for newcomers.
4. Sector Rotation
ETFs also make it very simple for novices to conduct sector rotation depending on different phases of the economic cycle. Assume an investor has invested in the biotechnology industry through the iShares Nasdaq Biotechnology ETF (IBB).An investor may choose to take profits in this ETF and invest in a more defensive area, such as consumer staples, via The Consumer Staples Select Sector SPDRFund (XLP).
5. Short Selling
Short selling, or the sale of a borrowed securities or financial instrument, is often a high-risk venture for most investors and should not be attempted by inexperienced investors. However, shorting ETFs is preferred than shorting individual stocks due to the decreased danger of a short squeeze (a trading situation in which a highly shorted securities or commodity rises upward) and the substantially lower cost of borrowing (compared with the cost incurred in trying to short a stock with high short interest).These risk-mitigation factors are critical for a novice.
Short selling using ETFs also allows a trader to profit from a wide investing topic. Thus, an experienced novice (if such an oxymoron exists) who is conversant with the hazards of shorting and wishes to start a short position in developing markets may use the iShares MSCI Emerging Markets ETF (EEM).However, due of the much greater degree of risk inherent with these ETFs, novices should avoid double-leveraged or triple-leveraged inverse ETFs, which seek outcomes equivalent to twice or thrice the opposite of an index’s one-day price move.
6. Betting on Seasonal Trends
ETFs are also useful for newcomers looking to profit on seasonal patterns. Consider two well-known seasonal patterns. The first is known as the “sell in May and go away” phenomena. It refers to the fact that US stocks have typically underperformed over the six-month period from May to October as compared to November to April.
The second cyclical pattern is for gold to rise in September and October due to increased demand from India ahead of the wedding season and the Diwali festival of lights, which occurs between mid-October and mid-November. The general market weakening trend may be utilized by shorting the SPDR S&P 500 ETF at the end of April or beginning of May and closing out the short position in late October, precisely after the customary market swoons of that month have happened.
A novice may also benefit from seasonal gold strength by purchasing units of a popular gold ETF, such as the SPDR Gold Trust (GLD), in late summer and closing the position after a few months. It should be noted that seasonal patterns do not always materialize as projected, and stop-losses are often advised for such trading situations to limit the danger of severe losses.
A newbie may need to hedge or protect against downside risk in a large portfolio, such as one inherited from a parent.
Assume you inherited a sizable portfolio of blue chips in the United States and are worried about the prospect of a major collapse in US stocks. Purchasing put options is one option. However, since most novices are unfamiliar with option trading tactics, another alternative is to open a short position in broad market ETFs such as the SPDR S&P 500 ETF or the SPDRDow Jones Industrial Average ETF (DIA).
If the market falls as projected, your blue-chip stock position will be properly hedged since portfolio losses will be offset by profits in the short ETF position. It’s also worth noting that if the market rises, your profits will be countered by losses in the short ETF position, limiting your winnings. Nonetheless, ETFs provide newbies with a reasonably simple and economical technique of hedging.
The Bottom Line
Many characteristics of exchange traded funds make them attractive products for starting traders and investors. Dollar-cost averaging, asset allocation, swing trading, sector rotation, short selling, seasonal patterns, and hedging are some ETF trading methods that are particularly ideal for beginners.
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