ETFs give low-cost opportunity to invest in broad index with the added advantage of high liquidity owing to its growing popularity among day traders. Online stock trading of ETFs can be carried out just like stocks. ETFs gives the same exposure to an industry group but with fewer risks as compared to stock trading.
What Are ETFs?
ETFs can be defined as a type of security that tracks an index, sector, commodity, or other asset, and can be purchased or sold on a stock exchange the same way as a regular stock. The price of ETFs fluctuates throughout the day and the amount of the assets is made to align with the original net asset value of the asset.
Net asset value of the asset is per share/unit price of the assets on a specific date or point of time and it helps to track the investment opportunities within ETFs. ETFs track indexes like the S&P 500 and try to replicate the index so that it aligns with it as closely as possible. The basket of securities can be bought or sold through a brokerage firm on a stock exchange.
ETFs can be considered as one of the best investment channels which resemble mutual funds. But the distinguishing difference between the two is that day traders can have access to ETFs in an open market whereas mutual funds are available only through Fund Management Company.
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What Are the Different Types of ETFs?
Day traders require ease of stock trading and diversification benefits of mutual funds. Both the advantages are combined in ETFs. ETFs are categorized on the basis of management type and on the basis of types of investments held.
ETFS based on management type:
· Passively managed ETF:
According to investopedia.com, a passive exchange traded- fund seeks to replicate the performance of the broad equity market or a segment of it by mirroring the holdings of a designated index. It is not determined by a fund manager and it provides great flexibility to day traders by listing fund weightings each day by matching ETFs with the entire performance of the market. Passive ETFs are a great investment option as it offers lower expense ratios and greater tax efficiency.
· Actively-managed ETFs
This type of ETF has a manager or a decision-making team to decide on the underlying asset classes. They choose stocks to outperform broader markets and indices. Actively managed ETF has benefits of tax efficiency, liquidity and price transparency. However, it is relatively costlier than passively-managed ETFs. The defining feature of actively-managed ETFs is that it gives day traders a solution to asset management.
Both passively-managed and actively-managed ETFs offer day traders the option to enter and exit the market on the same day of transaction.
ETFs based on investment held:
· Bond ETFs:
It invests exclusively in bonds like fixed-income securities like corporate bonds or securities. Bond indices can be accessed by ordinary day traders in an expensive manner. It adds liquidity transparency when market is stressed and has a portfolio of bonds which aids in diversification of the investments.
· Currency ETFs:
These investment vehicles offer day traders an exposure to overseas currencies and are passively managed. Currency ETFs track underlying currency pair (domestic and foreign currency) and the prices of the currencies can be speculated on the basis of political and economic changes in a country. Through portfolio of currencies, day traders are exposed to Forex markets.
· Stock ETFs:
It is a basket of stocks that tracks large businesses, small businesses or stocks from a particular country. The portfolio can be diversified by purchasing a whole collection of different stocks. They have lower fees but there is no actual ownership of securities.
· Industry ETFs:
They are also called sector ETFs which focus on a specific sector or industry like the energy sector ETF or technology sector ETF. As there is no direct ownership of assets, day traders are insulated from the downsides if the market. It is speculated by tracking the performance of the individual companies of the sector.
How Do ETFs Work?
- The fund provider pools the underlying assets and trades them in the stock exchange as shares produced through creation blocks.
- The performance of the underlying assets is tracked with the help of the corresponding ETF.
- ETF funds are listed on all major stock exchanges.
- Day traders can purchase and sell during the equity trading time.
- The share price of an ETF depends on the price of individual shares in the underlying assets.
- The share price of the ETF will be in proportion to the rise and fall of the prices of individual shares
Why Do Day Traders Prefer ETFs?
The primary objective of day trading is to make consistent profits within the opening and closing of an intraday trading. The high volatility of ETFs makes it the perfect candidate for day trading. If right strategy of investment is adopted, ETFs can generate huge profits. It is emerging as the preferred financial asset among day traders due to the following reasons:
Diversified:
ETFs offer day traders the opportunity to invest in different asset class through single ticker. It is a basket of stocks or securities which helps to build a diversified portfolio as it mimics a broad range of stocks. The index of ETFs can be accessed from big market indexes, domestic bond indexes or international stock exchanges.
Liquidity:
It is a convenient investment option whenever there is requirement of cash flow. The asset composition of ETFs and the trading volume of underlying assets influence its liquidity. It enables day traders to quickly and efficiently trade ETFs.
Volatility:
Volatility is very crucial for day traders as if there is no price fluctuations, there are less chances of making profit. ETFs are highly volatile as there can be swinging of share prices of underlying assets depending upon the market conditions.
Tradability:
The price of ETF is updated throughout the day and it can be traded just like stock in an open market. By closely watching the approximate daily price, the risk can be managed and reduced just like a stock.
Affordability:
The lower entry cost of ETFs draws day traders to invest particularly in passively managed ETFs. It offers A cheaper route to access sectors that are otherwise difficult to afford. It costs only a fraction of the amount of a stock. Compared to mutual funds, ETFs are more tax friendly. Both mutual funds and ETFs have Capital Gains Tax, but the amount of fee charged on ETFs is relatively small.
Day trading in ETFs- Basic steps to get started
Selecting a platform:
Find a suitable platform where brokers offer ETFs to trade.
Identifying the ETFs
Choose the best ETF that perfectly suits the intraday requirements.
Closely watch the statistics
Technical analysis of underlying assets like stocks, currencies and commodities has to be thoroughly conducted. According to daytradetheworld.com, the below given strategies can be used to day trade ETFs:
· Scalping
· Algorithmic trading
· Price action
· Swing trading
· Arbitrage
Examples of ETFs for day trading:
Ø Vanguard S&P 500 ETF (VOO): It tracks the S&P 500 Index which represents 500 companies in the U.S.
Ø Vanguard Total Stock Market ETF (VTI): It tracks CRSP U.S. Total Market Index.
Ø Schwab U.S Broad Market ETF (SCHB): This ETF tracks the Dow Jones U.S Broad Stock Market Index.
Bottom Line:
Day trading of ETFs has some degree of risk associated with it, similar to stock trading. If the day trader chooses the right ETFs, the realistic profit goals can be realized. Lowering the transactional costs can help overcome the occasional losses that one might incur.
