1-06 ETFs (Exchange-Traded Funds)

ETFs are a cross between mutual funds and stocks. ETFs are simply a portfolio of stocks or [ts]bonds[tm]A debt obligation of a company, the U.S. Treasury Department, or a city where the borrower receives funds (usually in increments of $1,000), makes semi-annual interest payments based on the coupon rate, and eventually repays the borrowed amount ($1,000) to the lender at the maturity date of the bond.[te] or other investments that trade on a stock exchange just like a regular stock does.

ETFs have the benefits of Mutual Funds in that one investment allows ownership in a group of [ts]Stocks[tm]Stocks are “equity investments” which means that individuals that own stock shares of a company actually own part of that company. [te], and usually that ownership is targeted to a specific industry, region or market segment (like gold stocks, financial stocks, small-cap stocks, or the Brazilian market). This built- in diversification is advantageous if you don’t like picking individual stocks but you have an interest in a particular industry.

However, there are differences of which you should be aware. Unlike Mutual Funds, the ETF prices change throughout the day as they are bought and sold based on the performance of the stocks that the ETF is holding. Some ETFs are also leveraged, which means that they have a multiple of 2x or 3x the performance of their underlying industry. This ability to react quickly makes them a favorite of day traders and other active investors because they are usually quite volatile.

Some ETFs are tied to an index, which make them “exchange-traded index funds”. For example, one of the most popular ETFs tries to mirror the composition of the Standard & Poor (S&P) 500, using their performance as an index (see the S&P 500 ETF, ticker symbol = SPY) and another tries to mirror the Dow Jones Industrial Average (ticker symbol = DIA).

ETFs are very popular and more often than not they are top % gainers for the week. Trading ETFs is great because you can ride the many ups and downs of specific sectors of the market like Agriculture, Energy, or even foreign countries.

The leveraged ETFs are extremely popular with traders. With the leveraged ETFs, when the sector gains 1 percent, the ETF can gain 2 or even 3 percent! See the chart below for a comparison between the NASDAQ banking sector index (IXF) and the Direxion 3x Leveraged Financial Bull ETF (FAS):

chapter1-6If you had invested in IXF in the summer of 2009, you would have done well, earning about 17% in one month. But if you had invested in FAS, you would have made a killing of over 70%! That is the power of leveraged ETFs. However, remember that leverage cuts both ways: up and down.


ETF 101

ETFs are the rage these days as many investors are shunning mutual funds. Why bother trying to beat the S&P500 anymore when you can just buy the S&P500 ETF (ticker symbol = SPY) and match the index’s performance.[endmark]

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