Exchange-traded funds (ETFs) are becoming more and more popular for traders and investors who want to capture broad indices, industries, and sectors. They have low expense ratios, high liquidity, a plethora of investment choices, easy diversification, and many more. However, if you’re going to invest in an ETF, you should also know the following trading strategies.
Dollar-cost averaging is arguably the most basic strategy you can use with an ETF. You buy a fixed-dollar amount of an asset regularly, no matter the changing costs of the asset.
One of the advantages of the dollar-cost averaging is that it maintains discipline during the saving process. This technique makes its inevitable that you pay yourself first.
Another advantage of this strategy is that by investing the same basic amount of dollar on regular intervals, you buy more units of the ETF when the price is low, and you buy fewer units when the price is high. You then average out the cost of your holdings.
Asset allocation refers to the technique of allocating a portion of a portfolio to different asset types such as stocks, bonds, commodities, and cash to achieve diversification.
And because ETFs often have lower investment threshold, newbie investors typically find it easy to perform basic asset allocation strategies based on his or her risk tolerance or time horizon.
Swing trades refer to trades that take advantage of sizeable swings in stocks or other instruments such as currencies and commodities.
These can range anywhere from a few days to a few weeks, making swing trading different from day trading, which involves trade that are never left open overnight.
ETFs and their characteristics make them suitable for swing trading, especially their diversification and the narrow bid/ask spreads.
At the same time, because ETFs are available on different asset classes and sectors, the investor can trade an ETF based on the sector or asset class with which he or she is familiar.
ETFs are also very useful when it comes to sector rotation technique, which in turn is based on the different phases of the economic cycle.
For instance, an investor may wish to get invested in a particular sector for a particular range of months, and then switch to another sector after those months.
Shorting or short selling refers to the sales of a borrowed security or financial asset. This strategy is one of the riskier techniques so it is not usually recommended for beginner investors.
On the other hand, short selling with the use of ETFs is advantageous for shorting individual stocks because of the lower risk of a short squeeze. A short squeeze is a trading situation in which a heavily shorted asset or security spikes higher.
Short selling through ETFs is also beneficial when it comes to lowering the borrowing cost of the shorted stock. For a beginner, these are risk mitigation considerations that should not be ignored.
Short selling through ETFs also lets traders gain some benefits from broader investing themes.