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Exchange Traded Funds, popularly known as ETFs, are a remarkable choice for new investors due to their numerous advantages such as low-cost ratios, plentiful liquidity, diversified investment options, minimal investment requirements, and more. Moreover, these characteristics make ETFs an ideal platform for various trading and investment strategies preferred by beginner investors. This article outlines the top seven ETF trading strategies for those just starting their investment journey, with no particular order of preference.
Key Insights
Dollar-Cost Averaging
Starting with the basics, Dollar-Cost Averaging is a strategy that involves consistently investing a fixed-dollar amount into an asset over a certain period, regardless of the asset's fluctuating price.
Beginner investors, often fresh entrants into the workforce with a stable income stream, can benefit from this strategy. They can take a small portion of their monthly savings and channel it into an ETF or a set of ETFs instead of letting it sit in a low-yield savings account.
Benefits
Two significant advantages of regular investing for beginners are discipline and cost averaging. By setting aside a portion of income for savings regularly, you practice financial discipline. On the other hand, by investing a fixed amount in an ETF monthly, you purchase more units when the ETF's price is low and fewer when the price is high, averaging the cost of your investment over time. This disciplined approach can yield lucrative results in the long run.
Let's look at a practical example: if you had been investing $500 each month from September 2012 to August 2015 in the SPDR S&P 500 ETF (SPY), your investment would have yielded an average annual return of nearly 13%, translating to a significant profit.
Asset Allocation
Asset allocation, which involves diversifying your portfolio across different asset categories such as stocks, bonds, commodities, and cash, is another powerful investing strategy. Given the low investment threshold for most ETFs, even beginners can adopt a basic asset allocation strategy based on their investment timeline and risk tolerance.
For instance, younger investors in their 20s might be more inclined to invest 100% in equity ETFs due to their longer investment timeline and higher risk tolerance. As they move into their 30s and begin experiencing significant life changes, they may opt for a less aggressive investment blend, such as 60% in equities ETFs and 40% in bond ETFs.
Swing Trading
Swing trading aims to capture substantial swings in stocks or other instruments like currencies or commodities over a few days or weeks. Unlike day trades, swing trades are often held open overnight.
The diverse nature of ETFs and their narrow bid/ask spreads make them suitable for swing trading. Moreover, ETFs cover different investment classes and a wide range of sectors, allowing a beginner with specific expertise or knowledge in a sector to trade an ETF based on that sector.
For instance, a tech-savvy individual might have an advantage in trading a tech-focused ETF like the Invesco QQQ ETF (QQQ). On the other hand, a newbie trader with a keen interest in commodity markets may prefer to trade a commodity-based ETF, such as the Invesco DB Commodity Index Tracking Fund (DBC).
Sector Rotation
ETFs offer a relatively straightforward way for beginners to implement sector rotation, which involves transitioning investments based on various stages of the economic cycle. For example, an investor who has invested in the biotechnology sector through the iShares Nasdaq Biotechnology ETF (IBB) may wish to rotate into a more defensive sector such as consumer staples using The Consumer Staples Select Sector SPDR Fund (XLP).
Short Selling
Short selling, or the sale of a borrowed security, is typically a risky venture for most investors and is usually not recommended for beginners. However, shorting through ETFs is often seen as safer than shorting individual stocks due to the decreased risk of a short squeeze—a scenario where a heavily shorted security surges higher. Also, the cost of borrowing is significantly lower. These risk-reduction factors are crucial for a beginner.
Advanced beginners, familiar with the risks of shorting, could consider a broad investment theme for short selling. For example, someone wanting to initiate a short position in the emerging markets could do so through the iShares MSCI Emerging Markets ETF (EEM). However, beginners should avoid double-leveraged or triple-leveraged inverse ETFs due to the considerably higher risk.
Capitalizing on Seasonal Trends
Seasonal trends in the market can offer insightful investment opportunities, and ETFs prove to be great instruments to exploit these trends. Understanding these trends allows beginners to make informed decisions that could potentially enhance their portfolios.
One well-known trend is the "sell in May and go away" phenomenon. This principle stems from the historical pattern where U.S. equities tend to underperform during the May to October period when compared to the November to April period. An investor could potentially profit from this trend by shorting a broad-based ETF like the SPDR S&P 500 ETF in late April or early May, then closing out the short position in late October, following the typical market dips observed during that month.
The second well-known seasonal trend revolves around the gold market. Gold prices have shown a tendency to climb in the months of September and October, largely due to increased demand from India during their wedding season and the Diwali festival of lights, which usually takes place between mid-October and mid-November. Investors can capitalize on this seasonal gold strength by purchasing shares of a gold ETF, such as the SPDR Gold Trust (GLD), in late summer, and then selling them after a couple of months when prices have typically risen.
However, it's crucial to note that these trends do not always materialize as expected, and market conditions can change due to a myriad of factors. Therefore, utilizing stop-losses on such trading positions is generally advised to limit the risk of significant losses. In essence, seasonal trends can be a profitable strategy, but they should be employed with caution and careful analysis.
Hedging
Hedging is an investment strategy designed to offset potential losses that may be incurred by other investments. It involves taking an opposite position in a related security, such as options or a short sale. For beginners, especially those who may find themselves managing a significant portfolio, hedging can provide a form of insurance.
Suppose a beginner investor finds themselves managing a substantial portfolio of U.S. blue-chip stocks, perhaps inherited. These stocks, while historically stable, can still be subject to market fluctuations and potential losses. The investor, keen on safeguarding the portfolio's value, may need to consider a hedging strategy.
In this context, the beginner can initiate a short position in broad market ETFs like the SPDR S&P 500 ETF or the SPDR Dow Jones Industrial Average ETF (DIA). Here's how it works: If the market goes down, leading to a decrease in the value of the blue-chip stocks, the short ETF position is likely to increase in value, offsetting the losses from the main portfolio.
However, it's important to note that hedging is not without its trade-offs. If the market rises, any gains in your portfolio may be offset by losses from your short ETF position. This means that while hedging can protect from downturns, it can also limit the profits when the market is bullish.
Hence, while ETFs make hedging relatively easy and efficient, beginners should understand that hedging is not about making money; it's about protecting it. The primary goal of any hedging strategy is risk reduction rather than profit generation. It is a tool to manage and control exposure to the uncertainties of the market.
Concluding Thoughts
ETFs offer several features that make them ideal for those just beginning their investment journey. Dollar-cost averaging, asset allocation, swing trading, sector rotation, short selling, seasonal trends, and hedging are all strategies particularly suited for beginners venturing into the realm of ETF trading.
