| | When you buy a stock, you're buying a piece of a company.
At least that was how things used to be. Now days, you can buy a stock and buy pieces of several companies. These stocks are called "ETF"s.
Why would you ever buy an ETF? Well, sometimes you want to leverage the expertise of people that know what they're doing who buy and sell several different related stocks at the same time. For example, you may want to buy a share in Johnson & Johnson, but you may not realize that 30% of Johnson & Johnson's profits depend on the price of the oil. In such scenario, an expert trader may hedge his portfolio by not only buying Johnson & Johnson's stocks, but also invest 30% of their money into an oil future. With such balance, the expert trader would not see a dramatic loss in his profits due to a skyrocketting of the oil price since his profits in the oil future would make up for his losses in the ownership of Johnson & Johnson. So you, being the neive investor who is not "in" on such knowledge, may wish to simply invest in a prepackaged stock bundle.
A prepackaged stock bundles are usually called "mutual funds" or "hedge funds." Or just simply "funds." Except mutual funds and hedge funds are not traded at any stock exchanges. When the exchange rules became less strict in the past several years, funds that are tradeable on the exchanges appeared. These are what we now call "ETF"s, which is short for "Exchange Traded Funds."
ETFs have their benefits compared to normal mutual fund or hedge fund investments. In order for you to trade in mutual funds or hedge funds, you need to hire a stock broker and pay the broker fees for keeping your portfoil maintained and keeping the mutual and hedge funds maintained. This is not so with ETFs - because these stocks are traded directly on the exchange, you can buy and sell at their face prices without paying anyone percentage commission, except for maybe the electronic service you're using to trade the ETF, which is usually a flat fee.
Also, since ETFs are just funds, you can have not only a bundle of long positions in stocks, but the bundle may also contain short positions in stocks. If you want to short a stock without the risks associated with shorting a stock, you can just buy an appropriate ETF. Recall that normally if you short a stock, you're borrowing a stock from someone else then selling it, with the hope that you can buy the stocks back at a lower price then returning the stocks back to the loaner with an interest and any dividends that were paid out during the time the stock was borrowed. This is a very complicated process and, depending on how the stock does, you can lose an infinite amount of money but the guaranteed gain is only the price of the stock - shorting a stock has all the risks with little potential benefit. But if you purchase an ETF, you're long in a fund which shorts stocks - so you gain all the benefits of shorting a stock without the risks of shorting a stock directly. That is, if you can find the ETF that shorts the stock you're looking for.
ETFs also have their downsides. Recall that the whole mortgage crisis happened because subprime mortgages were bundles with less-than-subprime mortagages. So be careful that the ETFs that you're purchasing has the stocks that you're really interested in without the stocks that you're not. Also, it's not always easy to find the ETFs that are good in quality at the right price - but that's always the case with any stocks you buy. So just keep your eyes open and understand what you're buying when you trade ETFs, just as you would with any responsible trade you do with regular stocks.
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| | Posted 11/2/2008 1:45 PM - 17 Views - 0 eProps - 0 comments
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