In this piece, we will take a look at the 10 best ETF trading strategies for beginners.
There are various forms and types of investments catering to different preferences. The stock market, appealing to those comfortable with risk, presents the chance to substantially increase wealth within a few months when well-timed bets are made, even if there’s a willingness to accept the potential loss of a substantial portion of the investment. Alternatively, dividend stocks provide a more reliable option for individuals seeking a consistent income. These stocks, associated with stable companies, typically experience steady share prices.
For instance, consider that in the last five years, the S&P500 has gained 81.10%, and the returns for the technology-focused NASDAQ 100 index are even more impressive, surging by an astonishing 154.60% during the same period. This provides savvy investors with an opportunity to potentially double their money, irrespective of the pace of interest rate hikes by the Fed, the level of inflation, or the possibility of an economic downturn. That said, not everyone finds investing in individual stocks suitable for their financial strategy. While acquiring shares from well-established companies like Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT) is unlikely to result in substantial losses, broadening the investment horizon adds complexity to the process. Investing in stocks necessitates an understanding of a company’s fundamental nature and an awareness of economic realities that can impact entire stock indexes.
For those seeking an alternative to the intensive research involved in stock investments, a popular choice is an exchange-traded fund (ETF). ETFs are portfolios of stocks typically curated by professional financial service providers such as BlackRock, Inc. (NYSE:BLK). These funds are generally based on industry sectors like healthcare, energy, or technology, or on stock and firm characteristics such as value stocks or growth stocks. Frequently touted as more cost-effective and superior to mutual funds, ETFs provide investors with affordable diversification, trading flexibility, and arbitrage opportunities. With ETFs consistently managing assets in the billions, the annual count of new ETF launches ranges from several dozen to several hundred. The popularity of ETFs is such that numerous brokerages extend free trading options to their customers for a selected range of ETFs.
ETFs have gained such widespread popularity that even Warren Buffett, one of the most renowned investors of our era and the head of Berkshire Hathaway, includes them in his investment portfolio. A review of Berkshire’s investments for the third quarter of 2023 revealed that Mr. Buffett allocated $16.84 million to the SPDR S&P 500 ETF Trust (NYSE:SPY). This ETF is among the largest globally, boasting an AUM (Assets Under Management) value of $481.73 billion as of January 4, 2024.
To grasp the functioning of an ETF, let’s explore its creation process. The introduction of new ETFs necessitates approval from the financial regulator in the market where they intend to be listed. In the United States, for instance, the sponsor submits a plan to the Securities and Exchange Commission (SEC).
Now, regarding ETF trading: the creation and redemption process empowers authorized participants, such as market makers or trading desks at substantial institutional investors, to deposit shares of the listed securities into the ETF trust and generate ETF units. ETFs are actively traded on the stock market and are accessible throughout a trading session. Investors can acquire the fund units, or shares, similarly to purchasing shares in a company stock. This creation and redemption mechanism ensures that the ETF price aligns with its net asset value (NAV).
After novice investors have chosen to venture into ETF investments, the next step is to develop an investing strategy. Numerous ETF trading strategies are available for them to consider, contingent on their preferred approach, risk tolerance, timeframe, and overarching trading or investing objectives. Below, we will delve into some of the best ETF trading strategies for beginners.
An expert in the field of finance researching new markets and investment opportunities.
Our Methodology
To compile our list of the best ETF trading strategies for beginners, we meticulously examined multiple reputable sources presenting ETF investment strategies, such as etf.com. We amalgamated these strategies into a consolidated meta-list, assigning a score to each based on the frequency of their appearance. Subsequently, we ranked them accordingly.
10. Short Selling
Insider Monkey Score: 2
Short selling, involving the sale of borrowed securities or financial instruments, is typically a high-risk venture that most investors, especially beginners, usually avoid. This strategy entails selling at a higher price and subsequently repurchasing at a lower price, with the profit being the difference between the selling and buying prices. Short selling is a more perilous trading approach, especially when applied to ETFs, and its execution demands careful consideration.
However, utilizing short selling within ETFs also provides traders with the opportunity to capitalize on a broad investment theme. Therefore, an intermediate-level investor with an understanding of the associated risks may choose to initiate a short position in emerging markets using instruments like the iShares MSCI Emerging Markets ETF (NYSE:EEM).
9. Thematic Investing
Insider Monkey Score: 2
The thematic ETF investing strategy revolves around acquiring ETFs that center on trending investment themes rather than specific types of investment securities. For instance, a typical thematic ETF may focus on investing in stocks of companies poised to benefit from potential growth resulting from technological advancements, environmental considerations, or demographic shifts over time. Additionally, thematic ETFs offer a simplified approach for beginner investors to speculate in emerging and rapidly expanding sectors such as artificial intelligence, blockchain, or renewable energy. While broad small market cap indexes may include small companies, thematic ETFs provide investors with a more direct and targeted means of selecting niche areas for their investments.
With over 300 thematic ETFs available in the market, investors can explore opportunities in companies or sectors influenced by long-term structural trends. Among the notable thematic ETFs is the ARK Innovation ETF (ARKK), standing as one of the largest in the market. Nonetheless, beginners should note that, while thematic ETFs provide exposure to a specific sector or trend, this concentrated focus may introduce concentration risk. If the chosen theme or sector underperforms or undergoes a downturn, the ETF could potentially incur substantial losses.
8. Sector Rotation
Insider Monkey Score: 4
Sector rotation entails selecting sectors that are currently in demand. This ETF trading strategy is straightforward to implement, making it an ideal choice for beginners. ETFs further simplify the process for novices to execute sector rotation, allowing them to navigate different stages of the economic cycle. For instance, suppose an investor has been involved in the technology sector using the iTechnology Select Sector SPDR ETF (NYSE:XLK). In this scenario, the investor might decide to realize profits from this ETF and shift their investment into a more defensive sector, such as consumer staples, utilizing The Consumer Staples Select Sector SPDR Fund (NYSE:XLP).
Nevertheless, there are drawbacks associated with sector rotation. Achieving success relies heavily on precise market timing, which proves challenging due to the unpredictable nature of economic cycles. One of the most common pieces of advice offered to new investors is to avoid attempting to time the market—a principle that underlies the entire concept of sector rotation. Moreover, engaging in frequent trading can result in substantial transaction costs and may trigger tax implications, especially concerning short-term capital gains, depending on the specific investment vehicle holding your ETFs.
7. Seasonal trends betting
Insider Monkey Score: 5
Similar to various assets, ETFs may encounter seasonal fluctuations, depending on the composition of the underlying assets within the fund. Certain months, particularly September and October, often exhibit favorable performance for commodities like gold, driven by increased demand from India ahead of the wedding season. A novice investor can capitalize on this seasonal strength in gold by acquiring units of a popular gold ETF, such as the SPDR Gold Trust (NYSE:GLD), in late summer and closing the position after a few months. On the other hand, oil and natural gas may witness a surge in the UK during colder months when there is heightened demand for energy to heat homes and buildings.
Another approach to aligning with market trends is through the ‘sell in May and go away’ phenomenon, primarily associated with US equities. Historically, these equities have tended to underperform during the May–October period compared to the November–April period. That said, it is crucial to note that seasonal trends do not always unfold as predicted, and implementing stop-loss strategies is usually advisable for managing risk in such trading positions.
6. Buy-and-Hold Investing
Insider Monkey Score: 6
The approach of the Buy-and-Hold investing strategy involves purchasing and holding securities for an extended period, typically lasting ten years or more. ETFs are deemed favorable for long-term investments due to their cost efficiency, diversification, and diverse options. Index funds with minimal fees, exemplified by the S&P 500 ETF, have consistently outperformed actively managed portfolios over a decade or more, making this one of the best trading strategies for beginners.
According to many market experts, ETFs are well-suited for buy-and-hold strategies, primarily owing to their tax efficiency. In comparison to mutual funds, ETFs are often more tax-friendly because financial institutions can execute “in-kind” trades, swapping the underlying assets for others. This method avoids triggering capital gains for investors.
5. Hedging
Insider Monkey Score: 7
A hedging strategy entails the purchase or sale of an investment security to mitigate the potential decline in the value of another asset or security. For instance, an investor with a substantial long-term position in stocks might engage in short selling of a stock ETF or acquire inverse ETFs. This approach aims to generate a positive return if the value of the long stock positions decreases. In some cases, beginners may find it necessary to hedge against downside risk in a sizable portfolio, especially one acquired through inheritance.
Alternative forms of a hedging strategy may involve acquiring specific investments to offset the risks associated with a particular economic scenario. For example, an investor might opt to include ETFs designed for inflation, such as a commodity ETF, which have historically demonstrated better performance compared to the broader market during periods of high and increasing inflation.
4. Swing Trading
Insider Monkey Score: 7
Swing trading is a strategy where an investor seeks to capitalize on recent price momentum and anticipated short-term gains in stocks or ETFs. Unlike day trades, which are typically closed within a day, swing trades have a holding period that extends beyond a day, often lasting up to a few months.
ETFs possess attributes that render them suitable for swing trading, including diversification and tight bid/ask spreads. Moreover, the availability of ETFs across various investment classes and sectors provides beginners with the flexibility to trade in areas where they have specific expertise or knowledge. This allows them to choose ETFs based on a particular sector or asset class, enhancing their ability to execute successful swing trades.
3. Dividend Investing
Insider Monkey Score: 7
Several investors opt for dividend ETFs to implement an income strategy or to hold a diversified selection of quality stocks for long-term appreciation. Instead of conducting individual research to identify dividend-paying stocks, beginner investors can conveniently purchase a dividend ETF aligned with a specific strategy, whether it be focused on dividend appreciation or high yield.
Similar to individual dividend stocks, ETFs usually distribute dividends on a quarterly or annual basis. Investors have the option to receive these dividends as income, or they can opt for an automatic reinvestment approach, allowing the dividends to be used to acquire additional shares of the dividend ETF.
2. Asset Allocation
Insider Monkey Score: 9
Asset allocation, the practice of distributing a portion of a portfolio across various asset categories such as stocks, bonds, commodities, and cash to achieve diversification, stands as a potent investment strategy. The accessible investment threshold of most ETFs simplifies the process for beginners to establish a fundamental asset allocation strategy tailored to their investment time horizon and risk tolerance.
Numerous ETFs are inherently designed to provide diversification. For instance, an ETF that mirrors a broad market index, like the S&P500, typically comprises a portfolio of stocks representing a varied array of companies across different sectors. Nevertheless, it’s crucial to recognize that not all ETFs possess inherent diversification. Some ETFs, such as the iShares US Technology ETF (NYSE:IYW), which focuses specifically on the technology sector, may exhibit less diversification compared to broader alternatives.
1. Dollar-Cost Averaging
Insider Monkey Score: 9
Dollar-cost Averaging (DCA) involves consistently purchasing a fixed-dollar amount of an asset at regular intervals, irrespective of its changing market price. Typically, novice investors, often individuals in the early years of their careers with a steady income and the ability to save monthly, are encouraged to adopt this approach. Instead of depositing funds into a low-interest savings account, these investors can allocate a few hundred dollars each month towards investing in an ETF or a diversified portfolio of ETFs.
Implementing a DCA strategy can mitigate market risk because the scheduled purchases acquire shares at varying entry prices, potentially reducing the average cost, particularly in a bear market where prices are declining. Automating this approach is convenient through certain brokerage platforms that offer select ETFs at zero commission, thereby minimizing the overall investment cost, especially when making regular interval purchases.
You can also take a peek at Top 20 Most Unfriendly States in the US and 13 Most Profitable Renewable Energy Stocks.
Suggested Articles:
- The 10 Best Telecom Companies to Invest In
- 12 Best Undervalued Stocks to Buy According to Reddit
- Jim Cramer Stock Portfolio: 12 Recent Additions
Disclosure. None. 10 Best ETF Trading Strategies for Beginners is originally published on Insider Monkey.
