18 ETF Trading Strategies

18 ETF Trading Strategies: Guide To Exchange Traded Funds

ETF trading strategies can be a very nice addition to your trading strategy arsenal. This guide breaks down key ETF tactics including trend following, mean reversion, and more, to give you a better understanding of how you can trade ETFs. We’ll try to bridge the gap between theory and practice with each strategy to make you better prepared to make money in the ETF markets.

An exchange-traded fund (ETF) is a basket of securities that is traded as a single instrument, which you can buy or sell through a brokerage firm on a stock exchange. Investing in certain ETFs is mostly seen as a passive approach, but ETFs can also be actively traded using various strategies.

One of the most ideal investment vehicles for investors, ETFs have grown in popularity since they emerged on the financial markets. But what is an ETF, and how is it traded?

Trade Smart ETF Strategies

Table of contents:

Key Takeaways

  • ETF trading strategies involves various approaches such as trend following, mean reversion, sector rotation, and high-frequency trading (for example – there are many more).
  • Key aspects of ETF trading include its ability to offer diversification, real-time pricing, and flexibility for trades across a wide range of sectors, asset classes, and strategies.
  • While ETFs provide many benefits such as lower fees, convenience, and versatility, they also bear risks like market fluctuations, tracking errors, and liquidity challenges that must be carefully considered.
  • We show you a backtested ETF trading strategy with quantified trading rules.

In this post, we will discuss the following:

  • What is an ETF?
  • History of ETFs
  • ETF trading strategies
  • The pros and cons of ETFs
  • An ETF trading strategy
A diverse stock market portfolio

ETF trading strategies

We started this blog in 2012, and since then, we have created hundreds of ETF trading strategies. You can find all our ETF trading strategies here.

Most of the backtests on this website are tested on ETFs. For example, it could be SPY, XLP, USO, or TLT. As a rule of thumb, the difference between a future backtest and an ETF backtest should be minimal in liquid assets if you are trading the same opening hours. However, it would be best if you backtested yourself first.

18 ETF trading strategies

Since the financial crisis in 2008/09, we have witnessed explosive growth in the number of ETFs. The first ETF, SPY, which tracks the S&P 500, was incepted in 1993, but there were not that many ETFs for the next 15 years.

However, ETFs are great for both investing and trading. In this article, we look at different ETF trading strategies. Key strategies include:

  • Trend following
  • Mean reversion tactics
  • High-frequency trade execution
  • Sector rotation techniques

Every strategy comes with its distinct set of advantages and disadvantages.

We look at how you can wisely employ these ETF investment or trading strategies in the markets.

18 Best ETF Trading Strategies

1. Trend Following

Trend following is an established trading strategy, perhaps made famous by Ed Seykota and Richar Dennis. Trend following expert Micheal Covel defines the strategy as not aiming to time the market, but to capitalize on large price swings. This means you have many small losers but a few big winners that offset the losers, both upward and downward market directions (long and short).

You can employ such strategies on ETFs, stocks, and futures. However, it’s mostly used for single stocks or commodities.

Trend following is a great diversifier to mean reversion strategies:

2. Mean Reversion

Mean reversion suggests that, after a price moves in one direction, it tends to return to “normal” or average levels. Prices routinely oscillate around the mean or average price but tend to return to that same average price repeatedly. Thus, this is the opposite of trend following.

Mean reversion applies to other aspects in finance, such as volatility, earnings, etc.

This approach can be very effective in markets with limited range because it employs a systematic method using technical indicators such as Bollinger Bands and RSI to identify instances where assets are either overbought or undersold. Investors might adopt dollar cost averaging or scale-in strategies, which could help minimize risk while potentially improving returns.

The major stock indices and stocks have been very prone to mean reversion since futures trading started in 1982.

However, it’s essential to remember that return distributions are not distributed like the Bell Curve (normal distribution). Financial markets typically have a few outliers.

3. Momentum

Momentum is a bit like trend following. Assets that have momentum tend to continue in the same direction as the lookback period. For example, you can have a portfolio of the highest-performing ETFs judged by their total returns over recent months. Every month you can rebalance the portfolio by selling poor performers and buying strong performers.

Does momentum makes sense?

Yes, because stocks rising (or falling) over periods spanning from one month to 12 months, have shown the tendency to continue the trend over the same period in the future. For example, a stock that has risen over the last 3 months, is likely to continue this trend over the next months.

4. Sector Rotation

Let’s make an example to explain sector rotation:

Imagine sector rotation as a relay race, where the baton is transferred from one participant (or sector) to the next. Investors move their funds among various sectors depending on performance outcomes, handing off the baton from sectors that are lagging to those anticipated to excel.

For example, you might trade stocks, bonds, and gold and, at month’s end, switch to the asset with the best performance over the last N months. Of course, you can make any trading rules you want, as long as it’s backtested.

5. Arbitrage

We make an example to explain arbitrage:

Imagine discovering a product with varying price tags in different stores. You can buy this product in one shop, offering it at a reduced cost, and then sell it at a higher price in another store.

This practice fundamentally defines arbitrage trading, a tactic that capitalizes on discrepancies in pricing across multiple markets or assets. An example would be arbitrage between A and B shares.

Arbitrage is best left to institutions. This used to be a strategy for retail traders, but market efficiency has made this a game for big institutions.

6. High-frequency trading

High-frequency trading utilizes sophisticated algorithms and cutting-edge technology, allowing trades to be conducted quickly. High-frequency traders leverage their ability to process vast quantities of transactions within mere fractions of a second, seizing opportunities from the most minute price changes.

This is yet another strategy that is best left to institutions.

7. Quantitative trading

This website is all about quantitative trading.

Quantitative trading uses a rule-based model and calculation to predict future returns. It is a systematic trading approach that uses strict statistical trading methods to find odds and probabilities. You want to have a strategy with a positive expectancy.

When one quantitative trading strategy is found sound and robust (even better if you have many strategies), you have an automated trading system you can use a computer to trade. Automation is power; you can trade almost unlimited strategies via your computer or VPS.

8. Options trading

An option is a contract between a buyer and seller in which the buyer has the right (but not the obligation) to buy a security at a certain price (strike) within a certain time period (until it expires or becomes invalid). The seller is responsible for delivering the security if the buyer decides to assign the options.

You can speculate, trade or hedge using options. One popular alternative is to buy an ETF and sell calls (buy options) to generate “income”. If the calls are exercised, you must sell the ETFs to the buyer.

9. Volatility trading

Volatility is the rate at which the price of a stock increases or decreases over a particular period. 

Below is a chart that shows the 15-day Average True Range from the ETF with the ticker code SPY since its inception in 1993:

ETF trading strategies
ETF trading strategies

SPY tracks S&P 500 and the volatility typically goes up and down – a lot. The peak is during the Covid-mess in March 2020. Volatility indicator can be used for both when to buy and sell, and for risk management.

10. Statistical arbitrage

Statistical arbitrage is a trading strategy that:

  • Employs advanced mathematical models to spot and capitalize on price discrepancies among correlated ETFs or between ETFs and the assets they represent.
  • Takes advantage of short-lived mispricings in the market.
  • Is most successful when executed by traders who have a profound grasp of how markets operate and possess strong skills in analyzing data.

This is a strategy that is best left to institutions.

11. Pair trading

In pair trading, a strategy designed to be unaffected by market direction, you simultaneously create long and short positions within two correlated ETFs. The goal is to leverage movements in their relative prices to earn returns from either the coming together or moving apart of these ETF values, irrespective of broader market trends.

Pair trading is similar to market neutral strategies:

12. Market-neutral strategies

Market-neutral strategies aim to deliver consistent returns regardless of market conditions. By equalizing long and short positions, they strive to lessen the effects of market volatility, allowing investors to concentrate on the performance of specific ETFs rather than wider market movements.

13. Global macro trading

They involve scrutinizing multiple elements such as economic policies, interest rates, and geopolitical changes to make educated choices when trading ETFs across diverse countries and asset categories. Preferably, these trading rules need to be quantified.

Typically, such strategies are mainly traded by hedge funds.

14. Equal weight strategies

Adopting an equal weight tactic or strategy results in a balanced allocation of funds among the ETFs within an investment portfolio. This method:

  • Reduces the risk of overconcentration
  • Facilitates uniform exposure to different assets
  • May result in more consistent performance outcomes
  • Establishes a thoroughly diversified investment portfolio.

15. Smart beta strategies

Within the sphere of smart beta strategies, the lines blur between passive and active management. Smart beta tries to combine both.

These approaches aim to surpass standard market-cap-weighted indices or mitigate portfolio risk by implementing different weighting based on certain factors (small-cap, value. quality, etc.).

16. Currency hedging

You can resort to currency hedging to shield your international investments from the unpredictability and randomness of currency fluctuations. This can be achieved by using currency ETFs.

17. Fixed income strategies

Fixed-income securities are typically bonds, for example, TLT, which tracks US 20-year Treasuries. Most of these ETFs pay a monthly dividend.

By adding assets from the fixed-income category, investors can fine-tune the balance between risk and returns in their investment portfolios by diversifying to the bond market.

18. Commodities trading

Trading strategies for commodities utilize commodity ETFs to grant investors immediate exposure to the fluctuations in prices of basic goods, including precious metals like gold (GLD), energy sources such as oil (USO), or oil stocks (XLE). These ETFs provide an opportunity for diversification away from customary stocks and bonds for investors looking to capitalize on various market cycles and the worldwide trends in demand.

What is an ETF?

An exchange-traded fund (ETF) is a basket of securities traded as a single instrument. You can buy or sell an ETF through a brokerage firm on a stock exchange. An ETF can be bought and sold like a company stock during the day when the stock exchanges are open.

As with a stock, an ETF has a ticker symbol, and its intraday price data can be easily obtained during the trading day. But unlike a company stock, the number of shares outstanding of an ETF can change daily because new shares are continuously created and existing shares are redeemed.

An ETF can issue and redeem shares on an ongoing basis that keeps its market price in line with the underlying security it tracks. The same goes for stock trading strategies.

What asset classes do ETFs have?

Interestingly, ETFs are offered for virtually every conceivable asset class – from traditional investments to alternative assets like commodities or currencies.

ETFs are one of the most important and valuable products created for individual investors in recent years. Their innovative structures allow investors to short markets, gain leverage if they want, and avoid short-term capital gains taxes. Since the financial crisis in 2008 the growth has been explosive.

If used wisely, ETFs offer many benefits and are an excellent vehicle to achieve an investor’s investment goals. While they are initially designed for individual investors, institutional investors play a key role in maintaining the liquidity and tracking integrity of the ETF. They do this by purchasing and selling creation units, which are large blocks of ETF shares that can be exchanged for baskets of the underlying securities.

What are the different types of ETF?

There are different types of ETFs. The common ones include:

  • Index ETFs
  • Sector and industry ETFs
  • Foreign market ETFs
  • Bond ETFs
  • Commodity ETFs
  • Inverse ETFs
  • Leveraged ETFs

What is ETF Trading?

ETF trading refers to the process of buying and selling exchange-traded funds – diversified baskets of securities that trade on an exchange, much like individual stocks. An exchange-traded fund can include a variety of assets, from stocks to bonds and commodities, and is designed to track specific indices, sectors, or strategies. These investment funds offer a convenient way to diversify a portfolio through exchange-traded products, making it easy to trade ETFs for investors.

Offering the liquidity of stocks with the diversification of mutual funds, ETFs present real-time price adjustments and the flexibility to be traded throughout the day, making them an attractive option for investors looking to diversify their portfolios.

ETF trading on a stock exchange

What are the pros and cons of ETF trading?

ETF trading comes with its set of advantages and challenges. The pros are:

  • Diversification
  • Lower fees
  • Trading flexibility
  • Diversification

The cons mainly include liquidity concerns and tracking errors. You must weigh these factors carefully, considering how each ETF’s structure and the broader market environment might influence their investment outcomes. Tracking errors can be substantial over time. Many ETFs are only used for short-term ETF trading because of the tracking error.

What are the most popular ETFs to trade?

The most popular ETFs to trade are technology-centered ETFs and those connected with major indices, for example, the SPDR S&P 500 ETF Trust (SPY), have risen as preferred options among traders.

Cost efficiency in ETF trading

What are the key benefits of ETF trading?

The key benefits of ETF trading are the diversification of a varied portfolio, the cost-effectiveness typical of these investment vehicles, and the ease of buying and selling them like stocks. This makes them useful for both trading and diversification.

These funds also offer fiscal perks alongside options such as margin trading or short selling, giving investors a flexible instrument to customize their investment holdings to match their specific monetary objectives and risk tolerance.

Can ETF trading be suitable for beginners?

ETF trading is suitable for beginners due to:

  • Their affordability and straightforward nature
  • The simplicity of creating a diversified portfolio
  • Access to extensive market coverage while avoiding the challenging process of selecting specific stocks

Beginners can attain wide exposure to different sectors and indices through a broad market ETF, thus avoiding the time consuming and risky undertaking of choosing individual stocks.

Diversification in ETF trading

How does diversification play a role in ETF trading?

Diversification is a safeguard against market fluctuations in ETF trading. ETFs allow investors to allocate investments across a wide range of asset classes and sectors, reducing the potential for substantial losses associated with any one security or section of the market.

The broad array of ETF options available to investors – from global equities, fixed income, and commodities to commodities ETFs- including equities ETFs enables them to build strong and diversified portfolios.

How do expense ratios affect ETF trading profitability?

Expense ratios affect ETF trading profitability by influencing the overall cost of holding and trading the ETF, directly impacting investors’ potential returns.

Expense ratios determine the profitability of an ETF, as they represent annual fees deducted from the fund’s assets and can gradually erode your returns over time. As a result, investors who prioritize cost-efficiency typically seek out ETFs with lower expense ratios to increase their possible earnings and ensure a more significant portion of their invested funds remains active within the market.

How does liquidity impact ETF trading?

Liquidity impacts ETF trading by influencing the ease with which ETF shares can be bought or sold. Higher liquidity typically results in tighter bid-ask spreads and lower investor trading costs.

Liquidity is a critical factor in ETF trading, influencing everything from bid-ask spreads to the ease of transaction execution. Those ETFs with lower liquidity might pose challenges, particularly for larger trades.

What are the risks associated with ETF trading?

The risks associated with ETF trading include market volatility, liquidity concerns, and tracking error potential.

Can ETFs be used for day trading??

Yes, ETFs can be used for day trading. For example, SPY and QQQ are excellent tools for day trading due to their liquidity and tight spreads (the difference between bid and ask prices).

What are some common mistakes to avoid in ETF trading?

To avoid common mistakes in ETF trading, avoid excessive trading and timing the market too frequently unless you have a backtested trading plan involving many different strategies. However, this applies to sorts of trading.

Another common mistake is to ignore the tracking error, which, over time, can be significant.

Can technical analysis be useful in ETF trading?

In ETF trading, technical analysis can be useful, but we recommend that you backtest your trading ideas.

Popular ETFs on a stock market ticker

How does ETF trading compare to mutual fund investing?

ETF trading differs from mutual fund investing in that it involves buying and selling shares on an exchange, whereas mutual fund investing typically involves buying shares directly from the fund company.

If you buy an ETF, you know the price you’ll get if you use a limit order. You don’t know the price with a mutual fund – you buy or invest at unknown prices.

Furthermore, with an ETF you can buy and sell many times throughout the day, something you can’t with a mutual fund. As a rule of thumb, a mutual fund is not for trading.

What are the key differences between leveraged and inverse ETF trading strategies?

Both leveraged and inverse ETF trading strategies involve ETFs, but they differ in their approach. Leveraged ETFs aim to amplify returns through borrowing, while inverse ETFs seek to profit from declines in underlying assets.

Leveraged ETFs pursue greater returns by trying to magnify an index’s daily outcomes, whereas inverse ETFs strive for opposite results, offering opportunities for profit when markets fall.

Is ETF good for trading?

ETFs are good for trading. ETFs are even excellent for it. Their diverse nature caters to a broad spectrum of trading styles, from the conservative buy-and-hold to the more aggressive day trading. With benefits including diversification, accessibility, and cost efficiency, ETFs might be a good choice for many traders.

But remember, no investment comes without risk, and ETFs are no exception.

What are the benefits of leveraged ETFs?

The benefits of leveraged ETFs include amplified returns potential. Investing or trading in leveraged ETFs can be exciting as they amplify the results of a trading strategy, providing you with opportunities to seize substantial market gains without dealing with margin account complexities.

However, it comes with a significant risk and should only be employed by experienced traders who know what they are doing. Trading a leveraged ETF is thus both potentially lucrative and hazardous.

What are the benefits of leveraged inverse ETFs?

Inverse ETFs, which are leveraged, allow investors to capitalize on market declines without resorting to conventional short selling. They provide protection against market slumps and can be employed independently for bearish strategies, especially if you are looking for strategies that can complement your other strategies.

These ETFs intensify the opposite return of their reference benchmark index and present a tactical alternative for investors who foresee adverse market trends.

How do you trade an ETF strategy?

To trade an ETF strategy, you implement it by buying and selling exchange-traded funds based on predetermined criteria, preferably backtested.

Strategies like asset allocation, dollar-cost averaging, swing trading, sector rotation, and capitalizing on seasonal trends can be applied to ETF trading.

What is the swing strategy of ETF?

The swing strategy of an ETF involves capitalizing on short- to medium-term price movements by buying low and selling high within a defined time frame.

Swing trading is a tactical approach to investing that focuses on securing profits from an ETF within a short span, ranging from several days up to weeks, by maintaining positions beyond the daily closing. Most of the ETF trading strategies we have developed on this blog since 2012 can be labeled swing trading.

What makes ETFs different from stocks and mutual funds?

ETFs differ from stocks and mutual funds in their structure and trading mechanism. ETFs provide investors with the combined advantages of mutual funds and stocks. They are traded on exchanges similar to individual stocks, yet offer diversified exposure akin to mutual funds by encompassing a variety of assets aligned with an index or sector.

Are ETFs suitable for long-term investment?

Yes, ETFs are suitable for long-term investment due to their diversification, low expense ratios, and tax efficiency. They can be advantageous for building wealth over time. However, a few ETFs have a huge tracking error, and they are not suitable for long term investments. Thus, you must ALWAYS look at the historical tracking error.

Can you lose money with ETFs?

Yes, it is certainly possible to lose money with ETFs if the assets or index they track decrease in value, so it’s important to assess the risks before investing carefully. We recommend making strategies that are backtested on historical data.

What is the history of ETFs?

The history of ETFs can be traced to 1989, when Index Participation Shares for the S&P 500 was launched. However, a federal court in Chicago ruled that the fund worked like futures contracts.

In 1990, the Toronto 35 Index Participation Units (TIPs 35) was created.

However, it was in January 1993 that the first recognized exchange-traded fund, the S&P 500 Trust ETF (the SPDR or “spider” for short), was launched. This ETF quickly became very popular, and it is still one of the most actively-traded ETFs in the U.S. stock market.

Since 1993, the ETF market has grown tremendously, reaching 102 funds by 2002 and nearly 1,000 by the end of 2009. As of May 2020, there were more than 7,100 ETFs (from over 160 distinct issuers) trading globally, according to research firm ETFGI. On the U.S. stock market alone, ETFs are estimated at 5.83 trillion dollars, with nearly 2,354 ETF products as of 2021.

What are the pros and cons of ETFs?

The pros of ETFs include the following:

  • ETFs offer diversification: For most ETFs, just investing in one ETF can give exposure to not only several stocks but also multiple market sectors.
  • They trade like stocks: ETFs do not only give the holder the benefits of diversification but also offer the trading liquidity of equity. Unlike a mutual fund that is priced at the end of the day at the net asset value, an ETF trades like a stock.
  • Fees may be lower: Compared to mutual funds, which are actively managed funds, ETFs have much lower expense ratios because they are passively managed.
  • Dividends are automatically reinvested: The dividends from companies in an open-ended ETF are automatically reinvested once they are issued.

Despite the many benefits, ETFs come with some demerits. They include:

  • Lower dividend yields: For dividend-paying ETFs, the yields are not as high as owning a high-yielding stock or group of stocks. While the risks associated with owning ETFs are usually lower, the dividend yields are also lower.
  • Returns are skewed: Some ETFs are leveraged, and the returns on such ETFs are usually skewed. For example, double or triple leveraged ETFs can lose more than double or triple the index they track.
  • Tracking errors: A benchmark might increase 20%, but your ETF only rose 17% due to tracking error.

What is the best ETF strategy?

There is no best ETF trading strategy, period.

Instead, you want many trading strategies that trade different ETFs, time frames, and market directions – both long and short. The power is in diversification and strategies that complement each other. Diversification is the only holy grail strategy in trading.

Can you swing trade ETFs?

Yes, you can swing trade ETFs. The strategies in this video show examples of how they can be implemented. We believe swing trading is much better than day trading.

What are the advantages of ETF trading strategies?

The main advantage of ETF trading strategies is that you invest in a basket of stocks, reducing the chances of gut-wrenching adverse movements. A single stock can fall 100% and rise unlimited, forcing you to go belly up if you are short.

Moreover, ETFs can be a great substitute if you are trading single stocks: ETFs can be used for hedging or diversification, for example.

Also, if you are investing, you get exposure to the whole market in a second when you buy SPY or QQQ, for example.

What are the disadvantages of ETF trading strategies?

The disadvantage of ETF trading strategies is that you are unlikely to have huge winners. A stock can rise 500%, but this is unlikely for an ETF unless you have owned it for decades.

However, for most retail traders, the wisest thing to do is to buy different asset classes and let time do the compounding.

Are ETF trading strategies good for beginners?

Yes, ETF trading strategies are good for beginners. However, you should always start trading in a demo account and wait at least 12 months before you go live with a backtested ETF strategy. This is called incubation. We believe it’s better to trade ETFs before you start trading individual stocks.

Are ETF trading strategies best for long or short term trading?

Our ETF trading strategies are good for both long- and short-term. You want to diversify into several strategies that complement each other. As mentioned further up in the article, diversification is the only Holy Grail in trading, and this includes different time frames.

What are the best ETF trading strategies?

There is no single best ETF trading strategy; you want a portfolio. Again, you want diversification!

Can you day trade ETF trading strategies?

Yes, you can day trade ETF trading strategies, but day trading is significantly harder than swing trading.

Day trading is noisy, meaning it’s hard to find tradable patterns that last long. We believe the best opportunities for retail traders are using a longer time frame, such as daily, weekly, or monthly bars. If you are not successful at swing trading using daily bars, we believe your chances of success as a day trader are slim.

How do you trade ETFs?

ETF shares are traded in the same way that stocks are. In contrast to mutual funds, whose prices are determined after the market closes for the day, ETFs are priced and traded continuously throughout the trading day. They behave exactly like common stock in that they can be purchased on margin, sold short, or held for a long term. ETFs make it simple to begin investing and allow investors to buy many stocks or bonds at once.

How does an ETF work?

The provider of an ETF creates a fund designed to track the performance of certain assets and then sells shares of that fund to investors. The people who own shares in an exchange-traded fund (ETF) own a piece of the fund but not the assets that make up the fund. 

ETFs are structured to replicate the performance of a specific stock or bond market benchmark index, such as the S&P 500 index (SPY – the oldest ETF still trading), Russell 3000 index, and the Bloomberg US Aggregate Bond Index. Other exchange-traded funds (ETFs) track commodity prices by purchasing futures contracts or even physical commodities like gold (GLD). Exchange-traded fund (ETF) shares can be bought through a brokerage firm or an investing app in the same way that stocks can be bought.

How do ETFs make money? 

ETFs can generate income from their investments in underlying assets such as stocks and bonds. ETF investors can profit whenever the fund’s underlying assets, such as stocks or bonds, increase in value or distribute a portion of their profits to investors in the form of dividends or interests.

When you purchase an exchange-traded fund (ETF), you purchase a piece of a collection of assets, and you can buy and sell your piece during market hours. ETFs can help you diversify your portfolio while potentially lowering your risk exposure.

What does ETF stand for?

ETF stands for Exchange-Traded Fund. It’s a type of investment fund that is traded on stock exchanges, much like stocks.

ETFs typically hold assets such as stocks, commodities, or bonds. They generally operate with an arbitrage mechanism designed to keep the trading close to its net asset value, although deviations can occasionally occur. ETFs are popular among investors due to their liquidity, diversification, and relatively low expense ratios compared to traditional mutual funds.

Can you scalp ETFs?

Yes, you can scalp the ETFs, as you would any stock on the stock exchange. ETFs trade just like any stock. Trading an ETF that tracks the S&P 500 is similar to trading an S&P 500 e-mini — you analyze the price action and trade just like any other.

etf-scalping

That said, we believe scalping is mostly a waste of time. Scalping is extremely difficult, and very few succeed, mainly because stocks and ETFs are a zero-sum game. This applies to ETF trading SPY as well.

Why the stock market is a zero-sum game is better understood if you read our clickable link.

Can you day-trade ETFs?

Yes, you can day-trade ETFs (Exchange-Traded Funds). ETFs are traded on exchanges just like individual stocks, which means they can be bought and sold throughout the trading day. Day trading involves buying and selling financial instruments within the same trading day, attempting to profit from short-term price movements.

When day-trading ETFs, it’s important to consider factors such as liquidity, volatility, bid-ask spreads, and transaction costs. Some ETFs may be more suitable for day trading due to their higher trading volumes and tighter spreads, while others may be less conducive to day trading due to lower liquidity or wider spreads.

As with any form of trading, it’s crucial to have a well-thought-out strategy, manage risk effectively, and be aware of the potential tax implications of frequent trading. Additionally, day trading requires significant time commitment, market knowledge, and discipline to succeed.

Where do ETFs trade?

ETFs (Exchange-Traded Funds) trade on stock exchanges like individual stocks. This means that investors can buy and sell ETF shares through brokerage accounts during the trading hours of the exchange where the ETF is listed.

ETFs are traded on major stock exchanges such as the New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange (LSE), Tokyo Stock Exchange (TSE), and others, depending on where the ETF is listed. Trading ETFs on exchanges provides investors with liquidity and transparency and the ability to access a diversified portfolio of assets with the convenience of trading them like individual stocks.

ETFs are listed on a stock exchange and trade in a manner very similar to stocks. The SPY ETF enables investors to diversify their investments at a lower cost while gaining exposure to various asset classes, including equities.

How are ETFs taxed?

If you sell an ETF for more money than you paid for it, you may have to pay a capital gains tax on the profit. If you owned the ETF shares for less than a year, your profits from selling them are taxed at the same rate as your regular income (US investors and traders). If you have held the fund’s shares for more than a year, you will be subject to more favorable capital gains tax rates.

ETFs (Exchange-Traded Funds) are subject to taxation in several ways, similar to other investment vehicles like stocks and mutual funds. Here’s a breakdown of how ETFs are taxed:

  1. Capital Gains Tax: When you sell your ETF shares for a profit, you will be subject to capital gains tax on the profit. Capital gains are categorized into two types: short-term and long-term.
    • Short-term capital gains: If you held the ETF shares for one year or less before selling, any profit will be taxed at your ordinary income tax rate, which can be as high as 37% (as of today).
    • Long-term capital gains: If you held the ETF shares for more than one year before selling, the profit will be taxed at the long-term capital gains tax rate, which is typically lower than the ordinary income tax rate, ranging from 0% to 20% depending on your income level (as of today).
  2. Dividend Tax: ETFs may distribute dividends to their shareholders from the income generated by the underlying assets held in the fund. These dividends are taxable in the year they are received. The tax rate on dividends depends on whether they are qualified or non-qualified.
    • Qualified dividends: These dividends are taxed at the long-term capital gains tax rate, which is typically lower than the ordinary income tax rate.
    • Non-qualified dividends: These dividends are taxed at your ordinary income tax rate.
  3. Tax on Interest Income: Some ETFs, particularly bond ETFs, generate interest from their bonds. This interest income is taxable at your ordinary income tax rate.
  4. Tax Efficiency of ETFs: ETFs are generally considered tax-efficient compared to mutual funds due to their unique structure. Most ETFs have lower portfolio turnover, meaning fewer taxable events are triggered than actively managed mutual funds. Additionally, ETFs offer in-kind redemptions, which can help minimize capital gains distributions.
  5. Tax-Loss Harvesting: Like individual stocks, you can use tax-loss harvesting strategies with ETFs to offset capital gains and reduce your tax liability. This involves selling ETFs at a loss to offset capital gains or up to $3,000 of ordinary income per year.
  6. Wash Sale Rule: Just like with individual stocks, the wash sale rule applies to ETFs. This rule disallows the deduction of losses if you repurchase substantially identical securities within 30 days before or after the sale.

What are the risks of ETFs?

Some exchange-traded funds (ETFs) track highly specialized or even gimmicky stock market segments, making them more volatile than the overall market.

Also, leveraged exchange-traded funds (ETFs) that promise market returns that are higher or lower than the market are volatile, hard to understand, and risky for small investors.

Please keep in mind that the history of ETFs is rather short. Most of the growth came after the great financial crisis of 2008/09. This means they are not really tested during financial stress. Howard Marks, the famous bond investor, has repeatedly emphasized this fact.

 ETFs vs. Mutual Funds – What’s the Difference?

The main difference between exchange-traded funds (ETFs) and mutual funds is that ETFs, like stocks, can be bought and sold throughout the trading day. On the other hand, mutual funds can only be bought at the end of each trading day at a price based on the fund’s net asset value.

Exchange-Traded Funds (ETFs) and Mutual Funds are both investment vehicles that pool money from multiple investors to invest in a diversified portfolio of securities such as stocks, bonds, or other assets. However, there are several key differences between the two:

  1. Trading Method:
    • ETFs are traded on stock exchanges, just like individual stocks. This means their prices fluctuate throughout the trading day as they are bought and sold. Investors can buy and sell ETF shares anytime the market is open.
    • Mutual funds, on the other hand, are not traded on exchanges. Instead, they are bought and sold directly from the fund company at the end of the trading day at the fund’s net asset value (NAV), which is determined by the value of the underlying securities in the fund’s portfolio.
  2. Costs:
    • ETFs generally have lower expense ratios compared to mutual funds. This is because ETFs are mostly passively managed and typically track an index, so they incur lower management fees.
    • Mutual funds may have higher expense ratios due to active management, where fund managers actively buy and sell securities to outperform the market. This active management typically results in higher fees.
  3. Minimum Investments:
    • Mutual funds often have minimum investment requirements ranging from a few hundred to several thousand dollars.
    • ETFs do not have minimum investment requirements, and investors can buy and sell as few or as many shares as they want.
  4. Tax Efficiency:
    • ETFs are generally more tax-efficient than mutual funds. Because of the way they are structured, ETFs typically have lower capital gains distributions, which can help investors minimize tax liabilities.
    • Mutual funds may distribute capital gains to shareholders, which can result in tax consequences for investors, even if they didn’t sell any fund shares.
  5. Transparency:
    • ETFs typically disclose their holdings daily, allowing investors to see exactly which securities the fund holds.
    • Mutual funds usually disclose their holdings less frequently, often every quarter.
  6. Redemption:
    • ETF shares are bought and sold on the open market, so investors can trade them throughout the day at market prices.
    • Mutual fund shares are bought and sold at the end of the trading day at the fund’s NAV, which is calculated based on the value of the underlying securities in the fund’s portfolio.

Can you swing trade ETF, trading SPY?

Yes, you can swing trade ETFs because they trade like stocks, and SPY might be very good for swing trading if you have a backtested trading strategy. One interesting thing about some ETFs is that they have adequate liquidity and volatility that is neither too high nor too low. Unlike mutual funds, trading exchange-traded funds do not incur significant trading costs.

ETF trading SPY strategies

Since we started this blog in 2012, we have published plenty of free ETF trading SPY strategies and the best ones we charge money for.

You can find our ETF trading SPY strategies here: ETF trading SPY strategies

What are the biggest ETFs?

Some of the biggest ETFs are the ones that track a broad market index, such as the S&P 500 index, Russell 3000 index, Nasdaq composite index, and so on. They are often ETFs with a proven track record of profitability. SPY, the ticker code for S&P 500, is the oldest ETF still trading. It started trading as early as 1993.

Among ETF providers, the most successful ETFs have the most assets under management (AUM). Such ETFs usually have a high trading volume, which reduces the ask-bid spread.

Furthermore, a higher AUM indicates a higher quality fund that has been in operation for longer. The following are some of the most important ETFs in the US stock market:

SPDR S&P 500 ETF (SPY)

  • Issued by State Street Global Advisors
  • $373.3 billion in assets under management
  • 0.0945% expense ratio

This was the first S&P 500 index ETF, the first of its kind to be offered on the market. SPY is popular among both buy-and-hold investors and active traders.

The fund seeks to replicate the performance of the S&P 500 Index, which is a collection of stocks with large market capitalizations that are traded on U.S. stock exchanges. Because the SPDR 500 ETF is technically a unit investment trust (UIT), it is not permitted to reinvest cash dividends between asset distributions. As a result, the fund’s performance may deviate slightly from that of the index on which it is based.

The expense ratio is really low. By investing in SPY, you will most likely outperform most active money managers due to the low expense ratio compared to the fees offered by active managers.

Vanguard Total Stock Market ETF (VTI)

  • Issued by Vanguard
  • $271.6 billion in assets under management 
  • 0.03% expense ratio 

The VTI tracks the CRSP U.S. Total Stock Market Index, so the fund’s holdings are a reflection of the whole U.S. stock market. The fund is classified as a balanced fund because it invests in a diverse range of blue-chip, mid-cap, and small-cap stocks.

VTI is an extremely cost-effective fund with a low expense ratio (the lowest?). The AUM is also impressive, totaling more than 271 billion dollars. If you are unsure which index to follow or if you want to invest across a range of industries and market capitalizations, this fund may be a good fit.

The iShares Core MSCI EAFE ETF (IEFA)

  • iShares is the issuer 
  • $88 billion in assets under management
  • 0.07% expense ratio

IEFA’s portfolio includes developed-market stocks from Europe and Asia but no stocks from the United States or Canada. The company’s benchmark index, the MSCI EAFE, encompasses approximately 98% of all global equity markets outside North America.

Unlike most competitors, it does not exclude small-cap stocks from its portfolio but includes them in proportion to the market. The fund’s portfolio is primarily made up of assets from Japan and the United Kingdom.

The IEFA is an excellent option for short-term and long-term investors seeking exposure to markets outside North America because it is a well-diversified fund with low ownership costs. The fund holds nearly 3,000 stocks.

Which ETF is best?

For short-term traders, the best ETF is the one that makes them the most money. But that also depends on the trading strategy. So, the only way to know is to backtest your strategy across many ETFs to determine the one that works best for you.

The SPDR S&P 500 (SPY), established in 1993, has been the longest-lasting ETF. It may be the best for a long-term investor who wants an S&P 500-diversified portfolio. Additionally, we believe the ETF SPY is the best one to trade for short-term gains.

When did ETF trading start?

The first exchange-traded fund (ETF) to be listed in the United States was in 1993, and it is now regarded as a landmark ETF (SPY). The number of ETFs has increased since then. It was about 102 in 2002 and nearly 1,000 by the end of 2009. And since 2009 it has exploded worldwide.

Difference between ETF trading SPY and index fund?

The primary difference between an exchange-traded fund (ETF) and an index fund (a mutual fund that tracks a market index) is that ETFs can be traded (bought and sold) at any time during the trading day. On the other hand, mutual funds can only be bought or sold at the end of each trading day at their net asset value.

Can you explain how to trade ETFs?

ETF shares are traded similarly to stocks, offering flexibility and continuous pricing during the trading day. ETF trading (SPY) allows for easy analysis, buying on margin, short selling, and long-term holding. The SPY ETF, tracking the S&P 500, is known for its low expense ratio and historical performance. ETFs provide cost-effective diversification by allowing investors to buy into various securities at once.

What are the risks associated with ETFs?

Investors can assess ETF performance by analyzing historical data and expense ratios and tracking the underlying index or strategy. Backtesting their investment strategy across various ETFs helps identify the one that aligns with their financial goals and risk tolerance. Some ETFs, especially those tracking specialized segments, can be more volatile. Leveraged ETFs pose additional risks. Investors should be aware of these factors and carefully choose ETFs based on their risk tolerance and investment goals.

Summary

As we conclude, remember that the power of ETFs lies in their versatility and ability to adapt to your investment horizon, risk appetite, and financial goals. An ETF can serve many purposes, but only you can determine your needs. This blog writes mainly about trading, and the most liquid ETFs are suitable for day and swing trading. However, you must study the tracking error of the ETF to find out if it’s suitable for your aims.

And lastly, please make sure you backtest your trading ideas and put them in incubation for many months before you trade them live.

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