Getting started with ETF trading

As you may already know, an exchange traded fund (ETF) is an index fund or trust that is listed on a stock exchange and can be traded intraday just like an individual stock. Through the purchase or sale of a single security, with the same ease and low cost as a stock trade, you can participate in the collective performance of an entire stock or bond portfolio. Since the launch of the first domestic ETF by the American Stock Exchange in 1993 (the S&P 500 SPDR), the popularity of ETFs has grown by leaps and bounds! Presently, there are more than 300 ETFs that allow you to participate in the broad market indices, industry sectors, international, bonds, and even commodities!

While you are probably familiar with the most popular ETFs such as QQQQ (Nasdaq-100 Index) or SPY (S&P 500 Index), a multitude of both trading and investing opportunities for nearly any scenario can easily be found within the hundreds of various ETF offerings. The bad news, however, is that sifting through the numerous types and families of ETFs without a reference guide is a tedious and confusing process. Fortunately, we have already done this hard work and compiled the results in the Morpheus ETF Roundup, a FREE reference guide that groups all of the ETFs by sector and sub-sector and allows you to easily compare the various fund families that offer a product within each group.

To receive your FREE copy of the Morpheus ETF Roundup, simply right-click on this link, then select "Save Target As..." to download the file to your desktop. You will need Adobe Acrobat Reader in order to open the file, but your computer probably already has that installed. If not, you can download the Acrobat Reader software from adobe.com.

• Reduced risk of substantial loss - Do you ever wonder if you are going to wake up in the morning and find out your stock dropped 50% because the CEO was caught with his hands in the cookie jar? ETFs are automatically diversified equities, which greatly reduces this risk because there is minimal exposure to any one individual stock. In the iShares Semiconductor Index (IGW), for example, the biggest holding is Texas Instruments, which only has an approximate 8% weighting in that ETF. By trading ETFs, you can greatly reduce the risk of a trading catastrophe.


• Access to more markets - With ETFs, you now have access to markets that were previously difficult and expensive for retail investors to participate in. Government T-bonds, international markets, commodities, and even a currency ETF can all be traded with the same ease and commission cost of an individual stock. With new ETFs being created every month, the realm of trading opportunities keeps growing.


• Liquidity is never an issue - Unlike individual stocks, in which liquidity can greatly affect how a stock trades, all exchange traded funds are synthetic instruments. As such, the amount of average daily volume that an ETF trades is, for the most part, irrelevant. Even if a particular ETF had no buyers or sellers for several hours, the bid and ask prices would continue to move in correlation with the market value of the ETF that is derived from the prices of the underlying stocks. An ETF with a low average daily volume may sometimes have slightly wider spreads between the bid and ask prices, but you can simply use limit orders if this is the case. We trade for points, not pennies, so paying a few cents more on occasion is not a big deal.


• Lower trading commissions - Prior to the inception of ETFs, if you wanted to buy a basket of stocks within a particular industry sector, you had to pay a separate commission for each stock you wanted to buy. However, through trading in the sector-specific ETFs, you now only pay one commission to buy or sell short an entire group of stocks within an industry.


• Better odds of follow-through - You have identified a particular sector you would like to be in, place the trade, then watch every single stock in that sector go in the right direction EXCEPT the one you are in! Has this ever happened to you? With ETFs, you are at less risk of buying or selling short the wrong stock because you are buying or selling short an entire group of stocks within the sector or index. If you buy the Biotech HOLDR (BBH), it does not matter much if Morgan Stanley has a big sell order on Amgen because you also have exposure to many other stocks within the Biotech Index.


• No uptick rule - Unlike individual stocks, ETFs are not subject to the uptick rule that prevents the short sale of stocks on a downtick. This makes selling short an ETF much easier and quicker than with an individual stock.

• iShares - With more than 100 different exchange traded funds ranging from broad-based to commodities, the iShares family has the most diverse offering of ETFs. Issued by Barclays Global Investors, iShares consist of the following types of ETFs: broad-based, international, industry sector, fixed-income (bonds), and commodities.


• HOLDRS - Issued by Merrill Lynch, HOLDRS is an acronym that stands for HOLding Company Depositary ReceiptS (pronounced "holders"). Opposite of the PowerShares ETFs, the HOLDRS only change their underlying components and weightings when a company is acquired. This has had the unfortunate result over the years of certain companies within each sector developing a very high percentage weighting within each HOLDR. It is also important to note that the HOLDRS can only be traded in increments of 100 shares. Nevertheless, the HOLDRS remain one of the most popular families of ETFs on the market because they were also one of the first.


• PowerShares - Although a relatively newcomer to the ETF scene, we really like the PowerShares family of exchange traded funds because of the unique way in which they are comprised. Unlike many other ETF families in which the underlying stocks rarely change, the PowerShares exchange traded funds use "dynamic indexing" in order to constantly search out the best performing stocks within each index. Based on a sophisticated quantitative selection process, "dynamic indexing" enables the underlying securities to change on a quarterly basis. PowerShares offers ETFs in the broad market, industry sector, and international.


• ProShares - Perhaps the most exciting thing to happen to the world of ETFs since their inception, the new ProShares family of ETFs enables you to take a bearish stance on the markets while actually buying an ETF. ProShares ETFs mirror the broad-based indices such as the S&P 500 and Nasdaq, but with an inverse price relationship. As the markets go down, the price of these ETFs go up (and vice versa). This is a major benefit to those of you who have a retirement account such as a 401k or IRA because you can effectively sell short the broad market without having a margin account. In addition, the ProShares family also includes a group of ETFs that follow the price of the major indices, but are leveraged 2 to 1. You can get more "bang for your buck" with these, but remember this can work against you as well.


• Vanguard - Better known for their diverse selection of traditional mutual funds, Vanguard offers a well-rounded set of ETFs ranging from broad-based to industry sectors. There are also a few international ETFs that primarily cover whole continents. There are presently more than 20 different ETFs available for trading and investing.


• SPDRs - SPDRS (pronounced "spiders") is an acronym for Standard & Poor's Depositary Receipts. There are more than 10 different SPDRS issued by State Street Securities or PDR Services, LLC. Two of the SPDRS track broad-based market indexes, while the rest are comprised of specific market sectors or industries (known as Select Sector SPDRS). The most popular is the S&P 500 Index Tracking Stock (SPY), which trades an average daily volume of over 60 million shares!


• StreetTRACKS - Perhaps the most well-known ETF in the StreetTRACKs family is the Gold Trust (GLD), which mirrors the price of one ounce of spot gold. It was the first exchange traded fund to track a commodity, but several more from other fund families have since followed. The StreetTRACKs family also offers ETFs in the broad-based market segments, as well as a handful of industry sectors.


• First Trust - A relative newcomer to the scene, there are presently only a handful of ETFs in this family, but we included them nevertheless. One of the more interesting funds in this family is the IPOX-100 Index Fund (FPX), which is tagged to the performance of a wide variety of initial public offerings (IPOs).


• Rydex - The most interesting family of ETFs from Rydex are the CurrencyShares, which track the price of various foreign currencies versus the U.S. Dollar. It's a great way to benefit from currencies trading without messing with the FOREX. Rydex also has a limited offering of ETFs focused on broad-based market segments such as small, mid, and large cap, as well as growth and value-specific funds.


• WisdomTree - A newcomer to ETFs, Wisdom Tree has launched a family of ETFs whose underlying stocks are weighted based on how much dividends they pay as opposed to their total market cap. This is a unique concept that may serve long-term investors well.