ETF Trading
How to trade ETFs: choosing liquid funds, order types, spreads and premiums, sector and leveraged ETFs, and the strategies traders use with ETFs.
ETF trading means buying and selling exchange traded funds to profit from moves in whole markets, sectors, commodities or themes. ETFs trade exactly like stocks, with live prices and every order type, but each share represents a basket of assets. That makes them a convenient way to trade a view on the S&P 500, technology stocks, gold or long term bonds without picking individual securities.
Why traders use ETFs#
- Broad exposure in one trade: a single order gives you a whole index or sector.
- Liquidity: the largest ETFs trade tens of millions of shares a day with one cent spreads.
- Flexibility: long, short, options and margin are all available on popular ETFs.
- Less single company risk: a bad earnings report from one company has a small effect on a broad fund.
Choosing an ETF to trade#
| Check | Why it matters |
|---|---|
| Average daily volume and spread | Determines your trading costs |
| Assets under management | Larger funds are usually more liquid and less likely to close |
| What it holds and how | Physical holdings, futures or derivatives behave differently |
| Expense ratio | Matters more for longer holds |
| Premium or discount to NAV | Thinly traded ETFs can trade away from the value of their holdings |
| Leverage or inverse structure | Daily reset changes behaviour over time |
Types of ETFs traders focus on#
- Broad index ETFs: S&P 500, Nasdaq 100, Russell 2000 and international indexes. The core instruments for trading the overall market. See Index Trading.
- Sector ETFs: technology, energy, financials, healthcare and others. Used to trade sector trends and rotation.
- Bond ETFs: short, intermediate and long term Treasuries, corporate and high yield bonds. Used for rate views. See Bond Trading.
- Commodity ETFs: gold, silver, oil and broad commodity funds. Check whether they hold the metal or futures. See Commodities Trading.
- Volatility ETPs: products linked to VIX futures; complex and usually decay over time. See The VIX.
- Leveraged and inverse ETFs: aim for 2x, 3x or minus 1x the daily return of an index.
The daily reset problem in leveraged ETFs#
Trading tactics#
- Use limit orders, especially at the open and close and for less liquid funds.
- Avoid the first minutes after the open, when ETF prices can deviate from their holdings while underlying stocks are still opening.
- Use relative strength: compare sector ETFs with the S&P 500 to find leading and lagging areas.
- Hedge with index ETFs: a trader long several stocks can short an index ETF to reduce market risk. See Hedging.
- Check events: ETFs are affected by the same macro events as their markets, and by rebalancing dates for leveraged funds.
Costs#
The spread is usually the main cost for traders. Commissions are often zero in the US. Expense ratios matter little for short trades but add up over long holds. Leveraged and complex products often charge higher expense ratios, around 0.9% or more a year.
Frequently asked questions#
Can you day trade ETFs?#
Yes. Liquid ETFs are popular for day trading because of tight spreads and deep volume. Pattern day trader rules apply in US margin accounts.
Are ETFs safer to trade than stocks?#
Broad ETFs remove single company risk, but they still fall with their market. Leveraged and inverse ETFs can be riskier than individual stocks.
Why does my ETF price differ from its NAV?#
Small differences are normal. Larger premiums or discounts occur in thinly traded funds, funds with illiquid holdings or during market stress.
Sources#
- U.S. Securities and Exchange Commission, Leveraged and inverse ETFs
- Wikipedia, Exchange traded fund
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Mentioned in
- Index RebalancingFundamental Analysis