How to start trading popular ETFs online?

How to start trading ETFs online?

Low costs, high liquidity, a high degree of transparency.

At AvaTrade, they talk about ETFs and discover this sensational market starting from its simplest foundations to guide you towards the trading strategies that are most suitable for you.

In this article, we will discover together what an ETF is and how it is born, and we will take a look at the dynamics of this market with great potential.

We will find out which types of ETFs are the most important and the advantages and disadvantages that they entail.

Read the article thoroughly if you are interested in fully understanding what an exchange-traded fund is, or use the chapters to browse only the topics that interest you most.

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What are ETFs?

Exchange-traded funds are investment products that can be traded on an exchange exactly as if they were stocks.

In Europe, the market on which they are traded is called ETFplus.

In some ways, they are very similar to mutual investment funds.

Their purpose is in fact to allow investors to combine their money in a fund that will be used to invest in stocks, bonds, or other assets, receiving interest on those investments in exchange.

The underlying can be a stock, a basket of stocks, commodities, a bond, or a market index.

The activity of the manager who issues the ETFs consists in ensuring that they maintain performances as similar as possible to those of their underlying reference.

ETFs are mostly passively managed funds that have the purpose of replicating the performance, and the return, of an asset.

For example, ETFs on indices, considered among the cheapest, belong to this category.

Few are those based on active funds, which require entry and exit commissions, management, and stock selection.

The market cost of an ETF is called TER and is expressed as a percentage of the traded amount.

Generally, it depends on custodian bank fees, supplier rights, and distribution costs, and does not include swap fees and any transaction costs for adjustments in the fund.

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How an ETF is born?

Before starting any trading, it is good to be clear on what we are investing in, and the first thing to know is that an ETF was created to meet the needs of investors “not wanting to put all the eggs in one basket”.

In fact, the first US ETF was created in 1993 to replicate the performance of the S & P500 index in order to guarantee access to the market even for retail investors.

Following the financial crises, their notoriety has increased dramatically and today the Investment Company Institute estimates that they represent 30% of all US equity trading, with a global trading volume that exceeded $ 6 trillion in 2020.

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How does the ETF market work?

ETFs are initially issued by a promoter also called a manager, who writes a list of securities that will make up the fund’s basket of shares/units, and establishes the investment objectives.

The list then passes into the hands of a so-called authorized participant (APs), who assembles and returns the basket to the promoter.

The latter then delivers the shares that are part of the basket to the APs, so that he can sell them on the stock exchange or to market makers (and therefore also to brokers).

The ETF then accesses the primary market, where it can be bought and resold by final buyers, ie traders.

One last aspect remains to be clarified: every time you buy or sell an ETF, you are in fact exerting a demand or supply force that will affect its performance.

How is it possible then to faithfully replicate the performance of the underlying, even if the two trades are independent?

Since when you trade an ETF you are not necessarily buying or selling the underlying, the trend of the two markets naturally tends to be different, and that is why their value must be constantly monitored.

APs are required to compensate for changes in demand by changing the availability of ETF shares or creating new ones or, conversely, redeeming them from the sponsor in exchange for securities.

There are also synthetic indexes or clones, the price of which is kept close to that of the underlying not through the creation and redemption mechanisms, but with the use of derivative contracts called swaps.

ETNs are a typical example, which we will see shortly.

If you are wondering why you should find an ETF interesting, well know that it is responsible for a very important process, called arbitrage.

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Arbitrage Trading on ETF markets

Arbitrage consists of the simultaneous purchase and sale of securities in order to take advantage of the price imbalance.

The market price of mutual funds and ETFs depends on the net asset value (NAV) of the underlying basket, and it is up to the APs to keep it constantly aligned.

However, the NAV of the underlying is communicated after each trading day, but ETFs are traded on the exchange intraday, and their value must be constantly updated.

The consequence is that often the market value of ETFs can differ from the NAV of the underlying, creating arbitrage opportunities both in the primary market, the one consisting of the Promoter and ApS, and in the second one, through open market operations.

Put simply, if the price of an ETF exceeds that of the underlying, arbitrageurs buy the underlying’s securities and sell the ETFs in return.

Conversely, if it is much lower, the reverse process takes place, i.e. they buy the ETFs and sell the underlying securities.

The aim is to bridge the gap between the market price of the ETF and that of the underlying security, and in this sense, it can be said that this type of arbitrage is a natural component of this market.

If the demand gap creates too much stress on the market, and the APs are unable to compensate for the imbalance, they will be forced out of the market.

ETFs would then still be tradable as closed-end funds in the secondary market, but it would no longer be possible to create new ones or redeem them.

In the chapter dedicated to advantages and disadvantages, we will better see the consequences of this mechanism.

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Advantages and Disadvantages of ETFs market

The benefits are clear to understand, and can be summarized in a few words:

Low costs

Composing a securities portfolio individually costs much more than investing in the single ETF that represents this group. The advantage is also evident compared to other investment funds such as mutual funds or actively managed ones, which can have very high costs and commissions.

Implicit diversification and risk management

Since ETFs consist of a basket of different stocks and market segments, they allow you to easily diversify your investments.

Transparency

You can easily know the estimate of the daily price change thanks to the ticker symbols and compare it with that of the underlying securities, thanks to the NAV issued daily. This way you are always aware of what your risk/reward profile is.

Flexibility and operational simplicity

ETFs can be bought both up (long) and down (short). They also do not expire and can be traded in batches of a single share, with potentially minimal amounts.

Tax advantages

Thanks to passive management, ETFs have lower charges than actively managed funds, and moreover, the tax on returns is generally collected only at the time of the sale of the ETF.

Issuer risk protection

As with other types of funds or SICAVs, the assets of an ETF belong exclusively to those who own the units or shares. In the event of default in the primary market, or bankruptcy of the fund manager, the ETF’s assets would not be affected.

Now that we have seen the indisputable advantages, let’s also take a look at the potential risks, which more than ETFs are related to the use we decide to make of them.

The so-called tracking error is the deviation of the ETF price from that of the underlying.

ETFs are financial products that aim to replicate the performance of the benchmark or reference basket, and as we have seen, an increase in the bid / ask spread can sometimes occur.

The resulting arbitrage possibilities can turn out to be advantages or disadvantages based on the position we choose to take in the market.

Finally, as regards diversification, it is true that it can greatly reduce the risks of the investment, but it will be up to us to choose a basket containing promising and reliable securities.

Fortunately, AvaTrade is ready to meet you here, offering you a wide selection of ETFs and allowing you to choose the most suitable for your trading strategy.

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What are the different types of Exchange-Traded Funds?

ETFs are part of a broad family of investment instruments, called publicly traded products, or ETPs.

This vast set includes many types of ETFs, which take their name from the underlying or from some specific features that characterize them, such as exchange-traded commodities/currencies and exchange-traded notes.

The former, known as ETCs, mimic the performance of an index referring to one or more or currencies; ETNs, on the other hand, which are more varied, can include all those assets that do not fall within the first two categories, issued by companies in order to replicate a reference benchmark, usually an index.

There are therefore many types of ETFs, which include equity, bond, commodity-based, currency, inverse, leveraged, and many others, divided by sector, underlying or specific characteristics.

The most common and important are undoubtedly those based on indices, which try to replicate a basket of stocks such as that of the S & P500, called SPDR or more simply “spider”.

For complete information on each tradable index visit AvaTrade’s financial instruments section, under ETFs.

Just click on the symbol of the ETF you are interested in to view all the information concerning it, constantly updated.

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ETF Trading with AvaTrade

ETFs include a wide range of markets, and to trade them you will need a trader who offers you access to these markets at advantageous prices.

AvaTrade only makes money from the spreads between Bid and Ask prices and unless otherwise specified the broker does not charge commissions on any trading operation.

AvaTrade also provides online CFD contracts on ETFs to give everyone the opportunity to easily leverage these valuable investment tools.
Through CFDs, the investor has the opportunity to trade ETFs directly from their trading platform in a simple way by exploiting extremely low costs of both bid / ask spreads and overnight interest rates.

Competitive prices

Spread of just 0.13% and transparent costs: all the synthetic and detailed information at the bottom of the ETF financial instruments page.

Leverage options

Leverage up to 1: 5 for retail clients and 1:20 for professional clients, as required by ESMA regulations for investor protection.

Trading your way

Wide choice of ETFs available and cutting-edge trading platforms.

Trusted broker

AvaTrade works all over the world, is regulated by 6 supervisory bodies and compliant with the European MiFID II regulation. In Italy, it operates under the passport regime of its license n. C53877 issued by the Central Bank of Ireland.

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What you need to know before starting ETF trading?

Now that you know about exchange-traded funds and the market connected to them, what are the next steps to follow?

1. Choose which ETF you intend to trade, and first decide what budget you want to dedicate to your investments. Remember that passively managed ETFs, such as indices, are more accessible and that the more diversified your portfolio is, the more you can spread the risks associated with trading.
2. Open a trading account with the broker of your choice and consider whether to request expert advice or if you prefer to take an example from more experienced traders with AvaSocial.
3. Decide how you want to place your investments, and what percentage of your budget to allocate to each type of ETF you have chosen
4. Draw up your trading plan, and consider for each investment the historical returns of the ETFs and securities, decide the risk you are willing to take and from that calculate your return potential, and help yourself by protecting your investments with orders limits and stop-loss, or discover the AvaProtect functions, Keep up to date with the main statistics of your reference ETF market, which for Italy is ETFplus, and be informed on performance, dividends, NAV, and any other report with a good economic calendar.
5. Never stop improving your knowledge, and always aim to learn as much as possible from each experience.

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How does ETF trading work? It is profitable?

ETF trading has become popular because it combines the ease of stock trading with the diversification that characterizes mutual funds.

Their purpose is solely to reproduce the performance and performance of the basket of securities that comprise it, known as the underlying.

There are many types of ETFs, including those based on indices, bonds, industries, commodities, currencies, and many others.

To access this market, you just need to open a trading account with the broker of your choice and decide how you want to share your investments.

They have transparent and very low costs while boasting considerable daily liquidity.

Their risk profile is the same as the assets they intend to follow, with respect to which they have lower tax burdens.

Like any other investment instrument, they can cause losses, and it is important to know the ETF you want to trade before investing, more than ever if you intend to make use of leverage and other instruments that if not used properly can amplify risks instead of earnings.

It would be enough to see how their market has grown in recent years to be convinced.

The very meaning of financial instruments is to create profit opportunities, but this does not mean that it will be enough for us to jump into ETF trading to become billionaires.

Carefully study the markets, deepen your trading strategies, always carefully calculate the risks before investing: in other words, the best way to get success from the markets is to trade responsibly, be it with ETFs or any other instrument.

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