What are ETFs and how to trade them

Types of ETFs

There are a range of ETFs available for traders and investors, depending on their goals, market preferences and risk appetite. We’ve gone through the main categories of ETFs below.

Stock index ETFs

Stock index ETFs are funds that track the performance of a given index. As stock indices are nothing more than a number representing a group of shares, traders and investors have to find ways to trade on their price. ETFs can enable you to gain such exposure from a single position, as they can track multiple stocks.

For example, a FTSE 100 ETF would track the performance of the FTSE 100, and would either hold physical shares of the index’s constituents, or products that mimic its price movements.

Currency ETFs

Currency ETFs enable investors and traders to gain exposure to the forex market, without having to buy or sell the underlying currencies. In some cases, these ETFs will only track a single currency, but for the most part they track baskets of currencies.

Currency ETFs can be used to gain exposure to the economic health of regions – such as the EU – or emerging market economies. They can also be used as hedge against inflation and foreign asset risk.

Sector and industry ETFs

A sector or industry ETF will track an index made up of companies operating within the same industry. Most industries will have an index that comprises of major stocks. For example, the gold sector has the S&P 500 Global Gold Index, which is comprised of securities from the sector including miners, researchers and producers.

Like currency ETFs, sector ETFs can be used to take advantage of changes in an economy’s health and as a hedge against any existing positions. If an investor or trader has significant risk in a particular sector, they can mitigate this risk by shorting a sector ETF.

Commodity ETFs

Commodity ETFs are not comprised of the underlying commodity, but rather derivative contracts that take their price from the commodity. This enables investors and traders to speculate on the price of commodities without worrying about the physical delivery or storage of the assets.

It’s important to note that there is a difference between commodity ETFs and commodity- linked ETFs, such as the sector ETFs described above. Commodity ETFs emulate the price of the underlying commodity, whereas commodity-linked assets track companies within the industry.

Inverse or short ETFs

Inverse ETFs are funds that move in the opposite direction to the underlying asset. So any movement that the asset makes, the inverse ETF does the opposite. They can be found on any of the above categories of ETF.

Investors and traders tend to use inverse ETFs as a means of opening short positions on the market. They can be useful hedges for existing long positions, or just a way of speculating on falling markets.

Leveraged ETFs

Leveraged ETFs are designed to mirror an underlying asset but use financial derivatives to amplify investors’ exposure. For example, a leveraged 2x ETF would maintain a $2 exposure to the underlying asset for every $1 of investor capital.

When using a leveraged instrument, losses can also be magnified. This is why it’s important to thoroughly research these ETFs and create a risk management strategy before a position is opened on them.