How to Invest in Exchange Traded Funds (ETFs)
Today's investors have many investment options available to them. Some give high returns but are highly risky (such as stocks and futures); and others give relatively low returns, but are less risky (such as ETFs and unit trusts). To become a good investor, you must be willing to do hours of research every day, follow financial news keenly, have the guts to take risks, and be able to recognize an opportunity when it is available.
If you want to invest your money but do not have an appetite for high risks, one investment option you should explore is Exchange Traded Fund (ETF). ETFs give better returns than many investment vehicles, but are less risky than stocks and futures. They are popular with investors who do not have the heart for the highs and lows of the stock market.
What is an Exchange Trade Fund?
An ETF is an investment fund traded in the stock exchange, which makes it sound like stock. But the difference is that the fund, which is pooled from many investors like you, is invested in a basket of stocks according to its stated objective. So you money could be invested in a number of tech companies, such as Apple and Microsoft. An ETF usually tracks a stock market index, such as NASDAQ and NYSE.
A stock market index is a single value that indicates the overall performance of all the stocks traded in the market. Examples of market indices are NASDAQ Index (USA), NYSE Index (USA), NIKKEI Index (Japan), FTSE Index (UK) and DAX Index (Germany). The value is computed based on the prices of selected stocks that are representative of the stock market. Many ETFS and mutual funds track this value to produce returns.
If your ETF tracks the NASDAQ index, its value will rise when the NASDAQ index rises and fall when the NASDAQ index falls. Unlike individual stocks, market indices do not normally go through huge fluctuations. This is what makes ETFs that track them considerably safer.
How Can You Buy and Sell ETFs?
ETFs are sold in units and each unit has a certain price, which rises and falls with the market index. You can buy and sell ETF in the same way that you buy and sell stocks - thorough a stockbroker paying brokerage commission. There is no sales charge. You can then follow your profit or loss using Metatrader or similar trading platform. You can take the following four types of actions when buying and selling ETFs:
- Long: Buy to take profit when the index rises.
- Short: Sell to take profit when the index falls (This is the same as buying, but in the reverse.)
- Limit order: Put a long order at a certain price below the current price or a short order at a certain price above the current price.
- Stop order: Put a long order at the price above the current price or a short order at a certain price below the current price.
- Profit limit: The price at which your trade will be automatically closed to take profit. You can set this price.
- Stop loss: The price at which your trade will be automatically closed to prevent further loss. You can set this price.
- Close: Close your trading when you have achieved your targeted profit or to prevent further loss.
How risky are ETFs?
ETFs are safer alternatives to stocks, but they are not riskless. Every investment has some risks associated with it. The main risks associated with ETFs are:
- Market risks: Risks arising from the fluctuations in the price of underlying securities
- Foreign exchange risk: Risks arising from the fluctuations in the exchange rate of the currency the ETF is traded in
- Tracking error: Risks arising from the inability of the ETF to fully replicate the performance of the market index it tracks
These risks are minor compared to the risk associated with stocks. If you want to trade in the stock exchange but do not have appetite for high risks, you should trade in ETFs. You may not make huge profits (sometimes you do), but your money will be safe. This is the reason ETFs are popular with investors who do not want to take huge risks. If you wish to invest in ETFs, talk to the stockbroker in your area.
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