Exchange Traded Fund or ETFs are funds that encompass a set of assets but are listed as a single instrument on the stock exchange.
If you are looking to diversify your portfolio, or you are not sure in which specific stock to invest, it is probably a good option to invest in ETFs on dotbig.com.
Next, you will learn about the types of ETFs that exist, how they work, some of the best ETFs to invest in 2021, and much more!
What is an EFT on the Stock Market?
An ETF (Exchange Traded Fund) is a listed investment fund. Unlike trading stocks or other assets, the ETF can encompass a wide range of markets in which the trader can invest his money.
An exchange-traded fund (ETF) is a group of securities that can be bought or sold on the stock market and that replicates the movement of the underlying assets included in your portfolio.
ETFs can include a wide range of asset classes, from the traditional shares of a company to other instruments such as currencies or commodities. Additionally, ETF structures allow investors to diversify, take advantage of leverage, and avoid short-term taxes on their earnings.
We may be talking about a market that represents almost 3 billion dollars in transactions , competing with the liquidity offered by the Forex market.
Essentially, ETFs are mutual funds that aim to track the performance of a specific index or asset.
↳ For example, the SP500 ETF tracks the performance of the SP500 index, which is a basket of the 500 largest listed companies in the US.
However, many investors use ETFs to benefit from diversification, as well as to access new markets.
For example, you may have recently heard a lot about the growth of AI (Artificial Intelligence). However, you may not know how to find the right company to invest or do business with, as it is still a very new area.
In this case, an investor could turn to the Global X Robotics & Artificial Intelligence ETF. This particular ETF seeks to invest in companies that can benefit from advances in the development of robotics and artificial intelligence. Thus, you can provide the investor access to a growing market, without having to directly choose a company individually.
Origin of ETFs
ETFs began trading in 1993, with the S&P SPDR being one of the first. However, it did not have much impact in the press, since it was considered as yet another financial instrument.
What many forget about the ETF's origins is that economist Harry Markowitz was one of those who laid the first bricks in its creation. His idea was to introduce some exchange-traded fund that was related to the most popular index: the SP500 . Today, this ETF has reached a value of more than 43.3 billion dollars, being one of the more than 170 ETFs that currently exist, only in the United States.
In 1996 iShares debuted in global ETFs, which contained a wide range of European, Asian and American indices, thus having the largest variety of ETFs, with more than 300 offerings. This launch caused a ripple effect in terms of the emergence of new ETF instruments that could be traded and accessed by the common investor.
The success of the ETFs forced the industry to launch one related to some raw material and the turn this time was for gold, which in 2004 was able to trade with an ETF called Gold SPDR (GLD).
Characteristics of ETFs
These are some of the characteristics of ETFs that help us understand what an ETF is:
✔️ They are traded as an equity security, as if it were a stock, which makes their price visible in real time.
✔️ They can be sold or bought at any time during the session.
✔️ They work as a single source containing various financial instruments, including fixed income securities.
✔️ They are not closed exclusively to corporate investors or large participants in the financial markets.
What are leveraged ETFs?
The basic definition of a 'leveraged ETF' is a fund that uses financial derivatives and debt to amplify the returns of an underlying index. These funds aim to maintain a constant amount of leverage over the investment time frame, such as a 2: 1 or 3: 1 ratio.
Leveraged ETFs use financial derivatives and debt instruments to constantly amplify the returns of an underlying index.
Due to the mathematical nature of these funds, the performance of investing in long-term ETFs will not necessarily match the index it tracks, especially those that are designed to act in reverse to the index of stocks.
As with other financial instruments, proper risk management is essential. It is important to establish a level of losses not exceeding 5-10% of the capital.
How do ETFs work?
Like a publicly traded company stock, an ETF can be traded for the duration of the session, with a ticker symbol and an intraday price. The market price of an ETF generally stays in line with the underlying securities it replicates.
As the price of an ETF deviates from the value of its underlying asset, market arbitrage occurs to align the price of the ETF with the value of the assets it replicates.
In general, exchange-traded funds are excellent investment options. They can be bought and sold in real time, just like stocks, and have lower brokerage fees.
ETFs are also beginning to replace mutual funds among investment preferences.
The end of the Part One.