Exchange traded funds (ETF) – an intro to speculation
By Neil Dennis
11:57, 4 June 2017
Exchange traded funds (ETF) are a collection of assets built into a single fund that can be traded on a stock exchange, much like the shares in a company.
The price of an ETF moves depending on the average value of the underlying assets within.
Why choose an ETF?
Because an ETF is essentially a basket of assets, price movements tend to be less volatile than single stocks.
There are ETFs for just about any trading strategy you can think of. You can trade emerging market currencies, precious metals, stock sectors – every base is covered.
ETFs trade in assets that are difficult for private investors to access. Oil, for example, is expensive and hard to purchase at market prices.
The same is true of many asset classes – particularly currencies and commodities.
Lower cost and risk
Although there are likely to be transaction charges, owning shares in an ETF incurs few of the costs or risks of owning individual assets. And when selling, ETF shares can be liquidated quickly at the current market price.
They can be traded easily through brokers and many electronic trading platforms.
Speculation vs investment
Speculation differs from investment in the level of risk. It is a trading strategy that aims to make as much profit as possible as quickly as possible, the caveat being that you could lose a significant part of your initial outlay.
Finding a strategy
We're going to cover three strategies here:
- Currency speculation
- Commodity speculation
- Emerging market speculation
These areas are among the most common for speculators, as there tends to be more volatility, and where there's volatility there are large price swings.
But remember the risks – large price swings can go down as well as up. Speculators must accept the risk that they could lose principal capital.
$$ Trading tip $$
Look for an ETF with high trading volumes – this is a sign that it provides good liquidity, and therefore accurate price discovery. It also means you can sell quickly. If your trade starts to go wrong, you may be able to get out before incurring too many losses.
1. Currency speculation
The foreign exchange (forex) market is inaccessible to private investors direct but is through funds – including ETFs.
Forex trading involves speculating about the performance of one currency against another – one of them is often the US dollar. Here are some examples of currency ETFs:
- Japanese Yen Trust ETF
- Australian Dollar Trust ETF
- US Dollar Bullish Fund
- UltraShort Euro Fund
Currencies move for a variety of reasons, the most common being economic data, so get to know the data releases – what they mean, when they’re published.
Online tracking
Professional forex traders, will have access to spot news alerts through their trading desk. You won't. The next best thing is the internet – many media groups have news alert services that are only a few seconds slower.
Look out for big market-moving data releases such as US Payrolls, GDP reports and any growth indicators – purchasing manager surveys, for example. And be ready to hit your buy or sell button whenever a central bank is about to make an interest rate decision – especially the US Federal Reserve.
Social media
Follow the right people on social media – market commentators from the Financial Times, Wall Street Journal and other financial media are all over this, and are sometimes quicker in disseminating market-moving news on Twitter than over the media they work for.
Geopolitical events also move currencies – the US dollar climbed sharply against the Russian rouble when Russian troops entered Ukraine in late 2014, and continued to rise as economic sanctions were later announced.
$$ Trading tip $$
Cut your losses. Remember: speculation is a risky business and if you lose, don't throw good money after bad. Don’t hold onto, or pour more money into, a losing trade because you have a gut feeling it will turn around. No one likes being wrong – just accept it and move on.
2. Commodity speculation
You really have to be alert to the news to make the most of opportunities in the commodity market.
Not only economic and geopolitical news (as above), but also weather reports – droughts in South America can affect harvests of important crops such as soya beans and coffee.
Examine quarterly production reports: miners and oil producers, as part of their reporting obligation, publish data on output from their facilities.
These can form a picture of supply in the following months and provide an alert to speculators that price movement is likely.
Follow markets
You must also follow other markets. Gold is renowned as a haven for investment. If you spot tensions in equity markets, emerging markets or other high-risk areas of investment, it’s likely the gold price is rising as investors seek safety and speculators make the most of the panic.
Find the correlations. Many commodities have correlations with other markets – some negative – but all can give clues to a likely price move.
Most commodities are priced in dollars, so when the dollar is doing well, many commodities drop in price as it becomes cheaper to buy them in alternative currencies.
ETFs are commonly available for most precious metals, base metals, agriculture and oil, and stock sectors such as gold mining and oil production also offer exposure to commodities.
$$ Trading tip $$
Speculators move quickly – waiting to make sure the market is moving in the direction you want could be an opportunity lost. And don’t wait too long to press the sell button once you’ve made a decent profit.
3. Emerging market speculation
Emerging markets (EM) can offer large growth opportunities, but their risk profile usually limits EM weighting in balanced investment portfolios. Speculators, however, can have fun with the options available through ETFs.
There are ETFs for EM currencies, various individual country stock index trackers, EM bonds and many more.
Similar circumstances as described above move Ems, but be more aware of local and regional politics – particularly in countries whose economies and markets are heavily managed by their governments.
Again, follow the economic data, central banks and government policy. And follow the experts.
So what’s the conclusion?
ETFs can offer the ideal way into speculative markets that aren’t directly accessible to private investors.
But remember: speculation is risky. You’re trying to identify phenomena that will produce large price swings. If you judge the market mood wrongly, you lose.
ETFs tend to be less volatile than individual assets – the multi-asset composition of most ETFs has a smoothing impact on price movement.