Mutual funds and individual equities have characteristics in common with exchange-traded funds (ETFs). They’re made up of a variety of securities, much like mutual funds, but they’re exchanged in shares on stock exchanges throughout the trading day, just like individual stocks. These cheap and versatile investment vehicles offer strategy alternatives to suit most investors, whether they choose a passive or active investing approach. These are a few of the other techniques and strategies that you can look into.
The act of moving investment assets from one area of the economy to another is referred to as sector rotation. The term “sector rotation” refers to the practice of utilizing the profits from the sale of assets in one investing sector to buy assets in another. This technique is designed to capture market cycle returns while also diversifying assets over a set holding time.
ETFs can make sector rotation for novices very simple, depending on the time of the economic cycle. Assume an investor has purchased the iShares Nasdaq Biotechnology ETF to invest in the biotechnology industry (IBB). Take profits in this ETF and switch to a more conservative sector, such as consumer staples, via The Consumer Staples Select Sector SPDR Fund (XLP).
Short selling, or the sale of a borrowed securities or financial instrument, is typically a hazardous venture for most investors, and not something most novices should do. Shorting individual stocks is preferable to shorting ETFs because of the lower risk of a short squeeze. A short squeeze is a trading scenario in which a heavily shorted security or commodity spikes higher and a substantially lower cost of borrowing when compared to the cost of trying to short a stock with high short interest. For a newbie, these risk-mitigation factors are crucial.
A trader can potentially take advantage of a wide investing trend by selling short using ETFs. As a result, an experienced novice who is aware of the dangers of shorting and wishes to start a short position in developing markets might use the iShares MSCI Emerging Markets ETF (EEM). Beginners should avoid double-leveraged or triple-leveraged inverse ETFs, which seek outcomes equivalent to twice or three times the inverse of a one-day price movement in an index, due to the substantially greater level of risk involved.
Betting on Seasonal Trends
ETFs are also useful for novices looking to profit from seasonal trends. Let’s take a look at two well-known seasonal patterns. The first is known as the “sell in May and leave” phenomenon. It refers to the fact that, historically, U.S. stocks have underperformed over the six-month period of May-October when compared to the November-April timeframe.
The other seasonal trend is for gold to rise in September and October as a result of increased demand from India ahead of the wedding season and the Diwali festival of lights, which comes between mid-October and mid-November. Shorting the SPDR S&P 500 ETF around the end of April or the beginning of May and completing the short position in late October, exactly after the market swoons characteristic of that month have happened, can take advantage of the broad market weakening trend.
A novice can profit from seasonal gold strength by purchasing units of a prominent gold ETF, such as the SPDR Gold Trust (GLD), in late summer and closing the position after a few months. It’s important to remember that seasonal patterns don’t always happen as expected, so using stop-loss orders to limit the danger of significant losses is usually a good idea.
In a large portfolio, such as one obtained via inheritance, a novice may need to hedge or protect against downside risk on occasion. Assume you’ve inherited a sizable portfolio of U.S. blue chips and are anxious about the possibility of a significant drop in the stock market. Purchasing put options is one option. Because most novices are unfamiliar with option trading methods, another alternative is to open a short position in broad market ETFs such as the SPDR S&P 500 ETF or the SPDR Dow Jones Industrial Average ETF (DIA).
If the market goes down as predicted, your blue-chip stock position will be properly hedged since the gains in the short ETF position will cover the losses in your portfolio. If the market goes up, your profits will be capped as well, because gains in your portfolio will be offset by losses in the short ETF position. ETFs, on the other hand, provide a very simple and effective means of hedging for novices.
ETFs offer a number of characteristics that make them great tools for new traders and investors. Including the first part of the article, the discussed trading strategies are some ETF trading techniques that are particularly appropriate for beginners. As an investor, you should select techniques that appeal to you the most.