Understanding ETFs
Hello traders, in this post I will explain different types of ETFs and what is an ETF (Exchange-Traded Funds).
ETF for example is a package of different stocks that have similar characteristics. One characteristic could be that they all are in the same sector. Some ETFs track indexes, commodities, and more. Those packages are listed on an exchange and are traded just like stocks.
Traders and investors use ETFs to diversify with the provided indexes (or other products) with lower costs, or if the trader can’t trade in futures contracts, it is possible to use ETFs that are related to a specific future. Also, there are options on ETFs that can be used as an alternative for expensive indexes.
Leveraged ETFs
Most of the ETFs are trading in a 1:1 ratio, for example, NASDAQ 100 is currently at $12621 and the relevant ETF QQQ is $307.8, the difference is 1 to 40, but the returns are the same (1:1).
The ETF NUGT on the other hand is moving with correlation to the gold miners index, but if the index return will be 10%, the ETF NUGT return will be 20%, because it is leveraged 2 to 1.
Those kinds of ETFs are not for investors or long-term traders, only for the short term. This is because the returns are multiplied by 2. If the index will move down 7% NUGT will move down 14%. Eventually, it will move substantially lower in price because there will be a major correction of 30%+ that will cause a 60%+ drop in price. Thus, there will be a split.
If you look at September 2012 you can see that NUGT price is $36000, this is because there were many splits due to the phenomenon I described above. NUGT was never really traded at $36000.
In the chart, the orange line NUGT. Moving 300% between March to August, the blue line GOLD 40%.
Reverse ETFs
ETFs that move in the opposite direction to the index.
For example, DUST is a leveraged ETF and going in the opposite direction to the gold miners index.
In the chart, the green line DUST. Decreasing substantial percents due to leverage.
ETFs that based on Futures
There are two types:
ETFs that own the commodity – those ETFs are moving almost the same as the commodity itself. For example GLD
In the chart above, the blue line is the GOLD price in cash, the red line is GLD.
ETFs that buy the futures of the commodity and not the physical commodity, don’t track the commodity with the same returns as the previous type, for example, VXX (VIX), USO (oil), UNG (gas).
As discussed in the previous post Futures have a time premium. When you buy ETF that is based on futures, that means that you buy also the premium attached to that future. As time passes, that premium is lost, and then the ETF buys the next contract with a new time premium. As time will pass, you will lose this premium also… and so forth… This is something to be aware of.
ETF for example is a package of different stocks that have similar characteristics. One characteristic could be that they all are in the same sector. Some ETFs track indexes, commodities, and more. Those packages are listed on an exchange and are traded just like stocks.
Traders and investors use ETFs to diversify with the provided indexes (or other products) with lower costs, or if the trader can’t trade in futures contracts, it is possible to use ETFs that are related to a specific future. Also, there are options on ETFs that can be used as an alternative for expensive indexes.
Leveraged ETFs
Most of the ETFs are trading in a 1:1 ratio, for example, NASDAQ 100 is currently at $12621 and the relevant ETF QQQ is $307.8, the difference is 1 to 40, but the returns are the same (1:1).
The ETF NUGT on the other hand is moving with correlation to the gold miners index, but if the index return will be 10%, the ETF NUGT return will be 20%, because it is leveraged 2 to 1.
Those kinds of ETFs are not for investors or long-term traders, only for the short term. This is because the returns are multiplied by 2. If the index will move down 7% NUGT will move down 14%. Eventually, it will move substantially lower in price because there will be a major correction of 30%+ that will cause a 60%+ drop in price. Thus, there will be a split.
If you look at September 2012 you can see that NUGT price is $36000, this is because there were many splits due to the phenomenon I described above. NUGT was never really traded at $36000.
In the chart, the orange line NUGT. Moving 300% between March to August, the blue line GOLD 40%.
Reverse ETFs
ETFs that move in the opposite direction to the index.
For example, DUST is a leveraged ETF and going in the opposite direction to the gold miners index.
In the chart, the green line DUST. Decreasing substantial percents due to leverage.
ETFs that based on Futures
There are two types:
ETFs that own the commodity – those ETFs are moving almost the same as the commodity itself. For example GLD
In the chart above, the blue line is the GOLD price in cash, the red line is GLD.
ETFs that buy the futures of the commodity and not the physical commodity, don’t track the commodity with the same returns as the previous type, for example, VXX (VIX), USO (oil), UNG (gas).
As discussed in the previous post Futures have a time premium. When you buy ETF that is based on futures, that means that you buy also the premium attached to that future. As time passes, that premium is lost, and then the ETF buys the next contract with a new time premium. As time will pass, you will lose this premium also… and so forth… This is something to be aware of.
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🧪 Feel confident with science and logic
💰 Trade your way to success and freedom
Feragatname
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