Seven Best ETF Trading Strategies for Beginners

• ETFs are an increasingly popular product for traders and investors that capture broad indices or sectors in a single security.
• ETFs also exist for various asset classes, as leveraged investments that return some multiple of the underlying index, or inverse ETFs that increase in value when the index falls.
• Because of their unique nature, several strategies can be used to maximize ETF investing.

1. Dollar-Cost Averaging

Dollar-cost averaging, the bare bones of investment strategies, is where we start. Using dollar-cost averaging, you can acquire a certain quantity of an item at regular intervals, regardless of how much or little its price fluctuates. Young adults who have been working for a year or two and have a steady salary and can afford to set aside a small amount of money every month are a common type of beginner investor.

These individuals should instead of putting a few hundred dollars a month into a savings account with a low interest rate, invest it in an exchange-traded fund (ETF) or a basket of ETFs.

Advantages

There are two main advantages to investing periodically for novices. First, it imposes discipline on the savings process. As many financial planners prescribe, it makes eminent sense to pay yourself first, which is what you achieve by saving regularly.

By investing the same fixed dollar amount in an ETF every month — the premise of dollar-cost averaging — you will accumulate more units when the ETF price is low and fewer units when it is high, thereby averaging out the cost of your holdings. As long as one maintains discipline, this strategy can yield substantial returns over time.

Suppose you invested $500 on the first of every month from September 2012 to August 2015 in SPDR S&P 500 ETF (SPY), an ETF that follows the S&P 500 Index. In September 2012, when the SPY units were trading at $136.16, a monthly investment of $500 would have yielded 3.67 units. However, three years later, when the units were trading near $200, a monthly investment of $500 would have yielded 2.53 units.

Based on closing prices adjusted for dividends and splits, you would have purchased a total of 103.79 SPY units over the course of the three-year period. At the closing price of $209.42 on August 14, 2015, these shares would have been worth $21,735, a return of nearly 13% annually.

ETF Trading Strategy

2. Asset Allocation

Diversification is achieved by allocating a portion of a portfolio to various asset categories, such as stocks, bonds, commodities, and cash. Asset allocation is a powerful investment technique. Depending on their investment horizon and risk aversion, the low investment minimum for most ETFs makes it simple for novices to implement a fundamental asset allocation strategy.

Due to their extended investment horizons and high risk tolerance, young investors may be fully invested in equity ETFs by the time they reach their twenties. As they enter their 30s, however, and undergo significant lifecycle changes such as starting a family and purchasing a home, they may shift to a more conservative investment allocation, such as 60% equities and 40% bonds. 

3. Swing Trading

Swing trades attempt to profit from large price fluctuations in stocks or other instruments, such as currencies or commodities. They can take from a few days to a few weeks to settle, as opposed to day transactions, which are rarely left open overnight.

Diversification and tight bid-ask spreads are the characteristics of ETFs that make them appropriate for swing trading. In addition, because ETFs are available for a wide variety of asset classes and sectors, a novice can choose to trade an ETF based on a sector or asset class in which they have specialized knowledge or expertise.

A person with a background in technology, for instance, may have an advantage when trading technology ETFs such as the Invesco QQQ ETF (QQQ), which monitors the Nasdaq-100 Index.

A novice trader who follows the commodity markets closely may prefer to invest in one of the many available commodity ETFs, such as the Invesco DB Commodity Index Tracking Fund (DBC).

Due to the fact that ETFs are typically collections of stocks or other assets, they may not exhibit the same degree of price appreciation in a bull market as a single stock. Likewise, their diversification makes them less susceptible than single securities to a significant decline. This provides some protection against capital erosion, an essential factor for novices to consider.

Trading with the Trendlines – Harmonic Patterns Strategy

4. Sector Rotation

In addition, ETFs make it comparatively simple for novice investors to implement sector rotation based on various phases of the economic cycle. Assume, for instance, that an investor has biotechnology holdings via the iShares Nasdaq Biotechnology ETF (IBB).An investor may wish to sell this ETF and invest in a more defensive sector, such as consumer staples via The Consumer Staples Select Sector SPDR Fund (XLP).

5. Short Selling

Short selling, the sale of a borrowed security or financial instrument, is typically a hazardous endeavor for the majority of investors, and novices should avoid it. However, short selling through ETFs is preferable to shorting individual stocks due to the lower risk of a short squeeze, which is a trading scenario in which a heavily shorted security or commodity spikes higher, and the significantly lower cost of borrowing (compared to the cost incurred when attempting to short a stock with high short interest). These risk-mitigation factors are essential for novices.

A speculator is also able to take advantage of a broad investment theme by shorting ETFs. Thus, an advanced novice (if such an oxymoron exists) who understands the risks of shorting and wishes to initiate a short position in emerging markets could do so via the iShares MSCI Emerging Markets ETF (EEM).Note, however, that beginners should avoid double- or triple-leveraged inverse ETFs, which seek results equal to twice or three times the inverse of the one-day change in an index’s price, due to the significantly higher degree of risk inherent in these ETFs. 

 

6. Betting on Seasonal Trends

ETFs are also useful instruments for novices looking to capitalize on seasonal trends. Consider two widely recognized seasonal tendencies. The first one is dubbed the sell in May and go away phenomenon. It refers to the fact that U.S. stocks have historically underperformed during the six-month period from May to October, compared to the period from November to April.

In September and October, gold tends to rise due to robust demand from India ahead of the wedding season and the Diwali festival of lights, which falls between mid-October and mid-November on average.The broad market weakness trend can be exploited by shorting the SPDR S&P 500 ETF at the end of April or the beginning of May and concluding the short position in late October, immediately after the typical market declines for that month have occurred.

Similarly, a novice can capitalize on seasonal gold strength by purchasing units of a popular gold ETF, such as the SPDR Gold Trust (GLD), in late summer and terminating the position after a few months.Noting that seasonal trends do not always occur as predicted, stop-loss orders are generally advised for such trading positions in order to limit the risk of large losses. 

Also read :- What is Currency Appreciation & What Causes it

7. Hedging

A novice may occasionally need to hedge or protect a substantial portfolio against downside risk, such as an inherited portfolio.

Suppose you inherited a sizable portfolio of U.S. blue chips and are concerned about the risk of a significant decline in U.S. stocks. Buying put options is an option. As most novices are unfamiliar with option trading strategies, an alternative strategy is to initiate a short position in broad market ETFs such as the SPDR S&P 500 ETF and the SPDR Dow Jones Industrial Average ETF (DIA).

If the market declines as anticipated, your position in blue-chip equities will be effectively hedged, as losses in your portfolio will be mitigated by gains in the short ETF position. Note that your gains would also be restricted if the market were to advance, as gains in your portfolio would be offset by losses in the short ETF position. However, ETFs offer novices a relatively straightforward and effective method of hedging.

The Bottom Line

Exchange-traded funds have a number of characteristics that make them ideal for beginning brokers and investors. Some ETF trading strategies especially appropriate for beginners are dollar-cost averaging, asset allocation, swing trading, sector rotation, short selling, seasonal trends, and hedging.