Master the art of ETF trading with these 5 proven strategies

ETFs are still kinda new, but they've gotten really popular fast. You can trade ETFs on stock exchanges like the New York Stock Exchange, just like you do with stocks. This is different from mutual funds, where you trade through brokers or directly with the investment companies, and orders only go through once a day. Since ETFs started in 1993, investors have loved them because they’re usually cheaper, more tax-efficient, and easy to buy and sell. But, how good they are can really depend on the specific fund, so it’s still important to check each one out carefully. This guide covers some common questions about how ETFs work, their costs, and how to start investing in them.

5 ETF Trading Strategies

Dollar-cost averaging (DCA)

ETFs are great for a dollar-cost averaging strategy, where you buy at regular intervals instead of all at once. This can lower your average cost over time, especially in a bear market. You can set this up easily with an automated investment program. Some discount brokers even offer certain ETFs with zero commission, which helps keep costs down when you’re buying regularly.

Buy-and-Hold Investing

Buy-and-hold means you buy investments and keep them for the long term, typically 10 years or more. ETFs are great for this because they’re low-cost, diversified, and offer lots of choices. A common strategy is to buy and hold index funds with low expense ratios, like an S&P 500 ETF, which has historically done better than most actively managed portfolios over 10 years or more. Generally, the ETF with the lowest expense ratio performs best over time. Since ETF fees are often lower than mutual funds, they fit well with this approach. This is a good approach for those not wanting to hold individual stocks.

Sector Rotation

For more advanced investors, sector ETFs let you move in and out of different market sectors, like health care, tech, financials, energy, and more. With sector rotation, you can shift your portfolio to sectors you think will do better, then switch to others when needed. For example, if you think a sector is overpriced, you might sell that sector ETF and buy another one you think will do better. Sector ETFs track the performance of a whole market sector, making it easy to manage a sector rotation strategy.

Asset Allocation

Building a portfolio starts with asset allocation, which is how you mix different assets like stocks, bonds, cash, and commodities. With lots of low-cost options in all asset types, ETFs are great for a diversified portfolio. For example, with just three ETFs, you could cover the entire U.S. stock market, the U.S. bond market, and a broad range of commodities. For more on asset allocation and picking ETFs, check out our article on choosing the best ETFs for long-term investing.

Swing Trading

Swing trading is when you try to make money from short-term price movements in a stock or ETF. The holding period is usually longer than a day but up to a few months. Swing traders often use widely traded stocks or ETFs because they have more predictable trading patterns than less-traded ones.

All ETFs are Not Passive

Many are, but not all. Passive investing tries to match the performance of an index, like the S&P 500. Many ETFs do this, which is why they're popular:

• They’re less dependent on a specific manager. If the fund manager leaves, someone else can just continue tracking the index.
• You can easily see how they’re doing. If an ETF performs well or poorly, it's clear it’s because of the index it tracks.

However, actively managed ETFs are becoming more common. Big mutual fund companies are starting to offer them. One reason for this is that fund managers like the daily transparency of ETFs, unlike mutual funds which only report quarterly. Combining a good manager with the cost and tax benefits of ETFs can be really advantageous. Still, active ETFs have their downsides, like capacity issues. Managers have to invest all incoming money, even if they don’t have the best idea for it. There are also smart-beta funds, which are index funds that make active bets.

Types of ETFs

There are many types of ETFs that invest in different asset classes. ETFs can also focus on commodities, factors, and almost any asset class. Some common types include:

• Thematic ETFs. These focus on specific sectors or themes, like ESG investing or cryptocurrency. They let investors tap into a theme without buying a bunch of individual stocks.
• Bond ETFs. These invest in fixed-income securities from governments, municipalities, or corporations. They’re good for mid-range goals or for those who want less exposure to stocks.
• Stock ETFs. These invest in a group of stocks from U.S. and/or international companies. They can be good for anchoring a portfolio or adding diversity.

Good Expense Ratio for ETFs

An expense ratio is the percentage of assets taken from a fund’s returns each year to cover costs like admin fees. The average expense ratio has been dropping for 20 years: As of 2022, the average for both ETFs and mutual funds was 0.37%. Instead of comparing mutual funds to ETFs, look at a fund’s strategy to decide on a “good” expense ratio. Broad market index ETFs that track the S&P 500 often charge less than 0.05%. Most fund categories have solid options charging 0.25% or less. Generally, niche strategies have higher fees, and active funds charge more than passive ones. Besides expense ratios, also consider transaction costs and holding costs to get a full picture of the cost of owning an ETF.

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Taxation of ETFs

ETFs are often praised for being more tax-efficient than mutual funds for a few main reasons:

• Many ETFs are index funds that don’t change the securities in their portfolio very often, so there are fewer chances to realize gains from selling a security.
• Authorized participants (specific firms with agreements with fund distributors) can do “in-kind transactions,” where securities are traded directly for ETF shares. Since the trade doesn’t involve selling a security for cash, it doesn’t trigger capital gains.
• Investors sell shares on an exchange against other market participants using outstanding shares. So, the ETF sponsor isn't affected by the transaction, and the shares outstanding for the ETF stay the same.

The tax efficiency that ETFs offer is a clear advantage, but keep a couple of things in mind:

• This tax efficiency varies depending on the asset class. For example, these tax advantages aren’t as good for bonds as they are for stocks.
• Tax-efficient doesn’t mean tax-free. You’ll still pay taxes on regular income distributions.

Choosing an ETF

Once you’ve decided if you want an active or passive strategy, start by checking out a fund’s Morningstar Medalist Rating. This forward-looking, qualitative rating helps you find funds likely to outperform over a full market cycle. The ratings—Gold, Silver, Bronze, Neutral, or Negative—are based on assessments of the fund managers’ strategy (Process), the people managing the fund (People), and the asset manager offering the fund (Parent).

Number of ETFs to Own

Short answer: There's no magic number. Asset allocation is the first thing to consider for your investment options. How close are you to your goal? How much risk can you handle? The answers to these questions will help you decide if you should look at equities, bonds, or other options. For some, one ETF can be enough if it’s diversified enough. For example, the Vanguard Total World Stock ETF VT includes stocks from around the world. This can be a good fit for passive stock investors who like the set-it-and-forget-it approach. On the other hand, if you want to be more hands-on, you might want to set your own asset allocations and invest in multiple ETFs. It really comes down to personal preference to some extent.

In choosing funds beyond the core categories, it’s important to see if those asset classes provide true diversification over existing holdings. Also find out if those asset classes meet a specific investment need that the current portfolio lacks.

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Conclusion

ETFs are low-cost investment tools that offer a lot of choices, letting investors use almost any kind of investment strategy—from classic buy-and-hold to hedging and thematic investing. Before picking a fund for your ETF investment strategy, make sure it fits your investment goals and risk tolerance. We hope this guide will help you to choose the best ETF investments.

This content was created by AI