ETF stands for “exchange traded fund”. In essence, an ETF is a portfolio managed by a financial institution. When you buy shares in an ETF, your money is allocated toward maintaining that portfolio. ETF shares are traded just like shares of stock. Swing traders hope to buy low and sell high, while options traders attempt to exploit leverage via puts and calls. ETF shares can be sold short as easily as can shares of individual stocks. Some ETFs even pay dividends that are a weighted average of the dividends paid by the stocks in the ETF. Long term investors, therefore, can buy and hold ETF shares.
Exchange traded funds offer more stability than shares of a single stock, since they are not dependent on the success or failure of one company. Most ETF’s have a theme. For example, some track a particular commodity, such as gold. Others focus on a sector like semiconductors, consumer staples, or pharmaceuticals. Such ETFs will be relatively stable with respect to price changes in an individual company, but can undergo price swings when a whole sector becomes popular or unpopular. ETF’s like the Nasdaq tracking stock, QQQQ, contain a variety of stocks and will be relatively stable even with respect to price changes in a given sector.
Some ETFs offer higher risk portfolios with the possibility of a higher reward. Growth ETFs focus on low-priced stocks with plenty of room for improvement. Emerging markets ETFs are comprised of stocks in corporations serving developing countries. Managers of value funds seek stocks they view as underpriced. Value funds generally contain stock in companies that have had long term success but are currently experiencing troubles reflected in the price of their stock. Such ETFs are riskier than the stable, dividend paying kind, but less risky than buying the stock in a new or troubled company. Because the ETF invests in several stocks, the failure of any one will not result in a total loss.
Not all ETFs are comprised of long stock. “Short shares” ETFs are portfolios of short stock. Other ETFs focus on currency trading, bonds, and other financial instruments. One of the benefits offered by ETFs is the ability to diversify your investment strategies without having to learn a new area of expertise. Stock traders who know little about currency trading, for example, can purchase shares in a currency-based ETF. A trader with no knowledge of a sector like semiconductors or pharmaceuticals can still make an investment in that sector without having to choose individual stocks; the choices are made by the ETF manager.
Because ETFs are portfolios rather than instruments based on a single company, they have inherently low volatility. Investors expect them to stay close to their current price, and hence options on ETFs tend to be low priced. As an options trader, I have no interest in ETFs as an investment. I find ETFs to be an impressive and clever investment product, I just personally have no use for them.