ETF Trading provides diversified exposure to major market indices.
ETFS // ETF TRADING PROVIDES DIVERSE EXPOSURE TO DIFFERENT MARKET INDICES AND SECTORS
Introduction to ETF Trading
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1. What is ETF Trading?
ETF is the abbreviated term for Exchange Traded Fund. ETF Trading involves trading on an exchange allowing you to buy and sell funds or underlying products in microseconds as easily as an individual stock through an exchange.
ETFs are managed funds listed on an exchange. The great benefit of an exchange-traded fund is that you are investing in a portfolio of shares rather than an individual stock so you get instant diversification, without having to buy all of the individual stocks that make up the fund.
ETFs are not just restricted to stocks, you can buy and sell ETFs that track futures markets, options markets, different styles of trading, like value or growth ETFs, bond markets and fixed interest markets. In fact, if you would like exposure to futures markets, but lack the capital and don’t like CFDs then ETFs are an excellent alternative. Some of the MyTradingAdvisor strategies favour ETFs over Futures and CFDs.
2. Types of ETFs
There are many different types of Exchange Traded Funds (ETFs) ranging from passive ETFs that seek to replicate the performance of a major market index or benchmark to actively managed ETFs that seek to outperform the market. In addition, ETFs cover foreign markets, sectors of the market, different investment styles and can even give exposure to commodity markets and derivative markets. Some of the main types of ETFs are as follows:
INDEX TRACKING FUNDS ON UNITED STATES INDICES
INDEX TRACKING FUNDS ON OTHER INTERNATIONAL MARKETS
FOREIGN CURRENCY ETFS
INDUSTRY AND SECTOR ETFS
COMMODITY MARKET ETFS
EXCHANGE TRADED NOTES (ETNs)
ACTIVELY MANAGED ETFs
OTHER ETF STYLES
KEY FEATURES OF ETFS
ETFs are exchange-traded and give you an entitlement to share in the capital growth and dividend distributions of the fund. Other key features are as follows:
ENTITLEMENT TO DIVIDENDS
CUSTODY WITH ONLINE BROKERS
LONG TERM INVESTMENT
Stock Exchanges generally have a Clearing House. Clearing Houses clear and settle Share Transactions executed on the Stock Exchange for an ETF. The primary role of the Clearing House is to guarantee the settlement of obligations arising under the ETF Transaction registered with it. This means that when your Stock Broker buys or sells ETFs on your behalf, neither you nor your broker needs to be concerned with the creditworthiness of the other side of the trade. The Clearing House will never deal directly with you, rather the Clearing House will only ever deal with its Clearing Participants – that is your broker (where your broker is a Clearing Participant), or where your broker is not a Clearing Participant, your ETF Broker’s Clearing Participant.
When a Stock Transaction is registered with the Clearing House, it is novated. This means that the ETF Transaction between the two brokers who made the trade is replaced by one contract between the buying broker (or its Clearing Participant) and the Clearing House as seller and one contract between the selling broker (or its Clearing Participant) and the Clearing House as buyer.
In simple terms, the Clearing House becomes the buyer to the selling broker, and the seller to the buying broker.
You, as the client, are not party to either of those ETF Transactions. Although your ETF Broker may act on your instructions or for your beneﬁt, the rules of the Clearing House provides that any contract arising from an order submitted to the market is regarded as having been entered into by the executing broker as principal. Upon registration of the ETF Trade with the Clearing House in the relevant Clearing Participant’s name, that Clearing Participant will incur obligations to the Clearing House as principal, even though the trade was entered into on your instructions.
The Clearing House ensures that it is able to meet its obligation to Clearing Participants by calling a margin to cover any unrealised losses in the market if the transaction incurred a borrowing component though this is more relevant to Margin Lending clients or ETF CFD Traders.
GO LONG AND SHORT
ETF traders typically employ the use of leverage to magnify potential returns. Because ETF traders are only holding stock for short periods of time, the downside risk can be lower than a buy and hold approach (but not in all cases) with the idea being to avoid adverse moves. As such there is more potential for a trader to utilise margin lending (or even ETF CFDs) to produce a return, not only on their own capital but on the borrowed capital as well. Unfortunately, the success rate on trading is rather low, so most traders get themselves into trouble with leverage because leverage also magnifies losses. The purpose of MyTradingAdvisor is to give you the necessary knowledge and experience to guide you towards becoming a profitable trader.
Traders need to save money on commissions and interest, hence trading online through a trading platform is the best option. MyTradingAdvisor facilitates trading on sharemarkets around the world through Interactive Brokers. Your brokerage account is held and funded directly with Interactive Brokers. MyTradingAdvisor provides training, troubleshooting, support and advice via our Traders Room but your counterparty risk on your brokerage account is direct with Interactive Brokers, not MyTradingAdvisor.
3. Take Both Long and Short Positions
With ETFs you can take either direction when entering a transaction or trade.
At MyTradingAdvisor we focus more on Swing Trading approaches to the markets though we do cover Systems Trading in detail and that includes systems that may buy and sell in the same day.
4. Calculating Profits and/or Losses:
This example is included for illustrative purposes only, and is not indicative of actual exchange rates or values.
- You purchase 10 ETF shares in SPY and the price at which you enter into the ETF is $250; and
- You later Closed Out the ETF by “selling” at a higher price of $280.
The resulting gross profit on the transaction would be $300 being sale price ($280) less buy price ($250) x 10 (the number of shares).
The net profit is determined after deducting commission, funding charges, transaction costs and any other charges.
The impact of fees on the net profit realised will be dependent on many factors and in particular, the length of time the open position was held as the funding charge is applied daily.
5. ETF Trading Examples
We have described how ETF Transactions work and the basic points of ETF Trading.
One of the key advantages ETFs have over other financial instruments is that relatively small lot sizes can be traded – lot sizes can be as small as 1 unit (one share or one dollar per index point).
In the US Margin Lending on ETFs can be a good alternative to using CFDs, which are banned for trading by US residents and citizens. Given the variety of ETFs available they offer a great way to get exposure to different views on the market. The inherent diversification from one ETF also saves a lot in transaction fees compared with buy or selling the individual stocks that make up an ETF.
Many ETFs are very liquid and also have liquid options markets which can be utilised to speculate on the price movement of the ETF or for generating extra income.
6. Key Benefits of ETF Products
ETFs provide a number of benefits which must be weighed against the risks of using them. The benefits of ETFs are as follows:
PROFIT POTENTIAL IN BOTH RISING AND FALLING MARKETS:
LOW STARTING CAPITAL REQUIREMENTS
TRADE FROM ANYWHERE
7. Margin Lending on ETFs
ETFs are subject to margin obligations when using Margin Lending and you must have sufficient balance in your Trading Account for security and margining purposes. You are responsible for meeting all margin payments required by your ETF Broker if you are using Margin Lending in conjunction with ETF Trading.
TYPES OF MARGIN
In order to enter into a Margin Lending Transaction on an ETF you will be required to pay your ETF Broker the Initial Margin or have an amount of Net Free Equity in your Trading Account that is at least equal to the Initial Margin. This amount represents your initial deposit on the ETF and you do not have to pay interest on this amount.
Depending on the particular ETF Transaction, the market volatility for the Underlying Product and the Trading Platform you use, the Initial Margin for an ETF Transaction will typically be between 30% and 50% of the face value of the ETF Transaction. However, it is not uncommon for Initial Margins to be above this range.
Margin Requirements differ depending on the Trading Platform you choose and the ETF Broker you choose. In choosing a Trading Platform, you should carefully consider the Margin Requirements of each Trading Platform as Margin Calls could have an adverse impact on your investment.
Your ETF Broker may, in their sole discretion and without the need to notify you, change the percentage Margin Requirements for an ETF from to time. You should refer to the Initial Margin schedule on your Trading Platform for more information about the Margin Requirements each time you enter into an ETF Transaction.
As the value of your ETF Trade will constantly change due to changing values of the Underlying Market, the Margin Requirement (being the minimum Trading Account balance you must maintain in order for your ETF Broker not to Close Out some or all of your ETF Positions) on the open positions will also constantly change. This is also commonly referred to as a Variation Margin. The amount of your Margin Requirements (being the Initial Margin and any adverse Variation Margin) at any one time will be displayed on the open positions report made available through your Trading Platform.
Any adverse price movements in the market must be covered by further payments from you (unless you already have sufficient “Net Free Equity” in your Trading Account). Your ETF Broker will also credit the Variation Margin to your Trading Account when a position moves in your favour.
Your ETF Broker determines the Variation Margin for an ETF Transaction by reference to changes in the value of the Underlying Product. In other words, each contract is effectively “marked to market” on a real-time basis. “Marked to market” means that an open position is revalued generally in real time or at least on a daily basis to the current market value. The difference between the real time/current day’s valuation compared to the previous real time/day’s valuation respectively is the amount which is debited (in the case of unrealised losses) or credited (in the case of unrealised profits) to your Trading Account. The valuations are calculated using the closing value (at the close of trading on each day) of the Underlying Product as determined by the relevant Pricing Source. Intraday “marked to market” revaluations will be based on the last available value of the Underlying Product as determined by your ETF Broker in their sole discretion.
Your ETF Broker will attempt to provide you with notice of any adverse Variation Margin by making a Margin Call (via ‘pop-up’ screens or screen alerts on the Trading Platform).
It is your responsibility to monitor your Variation Margin obligations. Any notification of a Margin Call will be via a ‘pop up’ screen or screen alert which you will only receive notice of if you access your online Trading Account via your Trading Platform’s website. There may be instances where your ETF Broker does not provide you with a Margin Call notifying you of an obligation to meet a Variation Margin. This does not waive your obligation to meet that Variation Margin. If you fail to meet a Variation Margin your ETF Broker may in their absolute discretion (but without an obligation to do so) Close Out, without notice, all or some of your open ETF Transactions.
Margin Calls are made on a net Trading Account basis i.e. should you have several open positions with respect to a particular Trading Platform, then Margin Calls are netted across the group of open positions. In other words, the realised and unrealised profits of one ETF Transaction can be used or applied as Initial Margin or Variation Margin for another ETF Transaction.
FAILING TO MEET A MARGIN CALL
If you do not meet Margin Calls immediately, some or all of your positions may be Closed Out by your ETF Broker without further reference to you.
Your ETF Broker generally applies risk limits (referred to as Default Liquidation Thresholds) to ensure that the percentage of your Trading Account balance which you are using at any one time to satisfy Margin Requirements (Margin Utilisation) does not exceed certain pre-defined levels. If your Margin Utilisation exceeds the Default Liquidation Threshold for your Trading Platform, a Margin Call will generally be applied to your Trading Account. If you do not meet a Margin Call immediately, your ETF Broker may Close Out some or all of your open ETF Transactions without notice to you.
The Default Liquidation Threshold is determined by the ETF Broker for your Trading Platform. It is implemented for risk management purposes, and may be varied by the ETF Broker at any time.