Exchange traded funds (ETFs) are just like stocks, but there is a major problem with them.
Do not buy or sell any ETF until you watch this warning.
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ETFs are a lot like a mutual fund, in that they hold a group of investments (stocks + bonds).
The beauty is that they trade just like stocks, and have lower commissions, and you can trade any time.
Each ETF is designed to mimic a specific investment or group of investments. So, for example, GLD attempts to copy the movements of gold prices. If you think gold will go higher, you can buy GLD. If you believe the economy of Africa will grow, you could buy AFK, if you want more exposure to Germany, you could purchase EWG, and so on.
Warning number 1, and this isn't what I need to tell you about in this video, sometimes trading can be thin, so use limit orders rather than market orders if you are going to trade them, especially true in the very early or very last trading minutes each day.
Anyway, here is the problem with ETFs which can cost you a huge amount of money. ETFs are actively managed, being continually rebalanced so that their holdings reflect the intention of the ETF.
For example, INDA is meant to mirror the action of a wide range of companies in India. It involves 85% of the Indian stock market, and needs to be adjusted on a daily basis to make sure it is staying true to its purpose.
With these adjustments comes a small management fee. Typically this expense will be very small, usually a fraction of a percent, and is typically less than a common mutual fund.
- straight-up ETFs are pretty good, but leveraged ETFs will destroy your investment.
- if tracking oil prices, USO will move very similarly to oil. If oil goes up 10%, the ETF may only rise 9.8%. This slight loss is barely noticeable, and it is called slippage.
Not a huge deal, but this happens every day. When you get into leveraged ETFs, this becomes a major problem.
For example, UWTI is designed to provide 3 times the return of WTI oil. If WTI goes up 1%, UWTI tries to rise 3%. Likewise, if WTI falls 1%, UWTI would fall about 3 times that much.
The problem is slippage. In reality if WTI rises 2%, UWTI is designed to climb three times that much, so 6%. However, in reality it may only gain 5.95%, for example. Then, if WTI falls 2%, it is back to where it originally started, but UWTI is designed to fall 3 times that amount, or 6%. In reality, it will likely fall a tiny bit more than 6.
These slight shortfalls get applied every day, so if you lose a fraction of your investment, again and again and again, you are suffering a slow bleed. You probably wouldn't even notice it on any single day, but that is why the long term charts of any leverage ETF are always in a slow, steady downtrend.
ETFs, especially the leveraged ones, are great for making a very short term call, but should never be used for long term investing. For example, if you expect oil prices to spike, you could play it by buying UWTI, but do it only as a short term trade. If you hold for weeks or months, you will almost certainly lose .
Protect yourself when trading ETFs. Consider avoiding buying or selling in the first few or final few minutes. And do not hold ETFs for extended lengths of time, especially the leveraged ones. .
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