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ETFs, also known as Exchange Traded Funds, are essentially mutual funds that are traded on a stock exchange like regular stocks of a company. However, unlike mutual funds that can only be bought and sold at the end of a trading session, ETFs can be bought and sold at any point throughout a trading session, just like stocks. Since an ETF combines the diversification benefits of mutual funds along with the liquidity of stocks, it is widely regarded by many investors as one of the best beginner-friendly investment options in the market. That said, there are several ETF trading strategies that many traders and investors use to profit off the liquidity and short-term price movements offered by the funds. If you’re on the lookout for some ETF investing strategies to employ, here are some that can help you out.
Key takeaways
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ETFs combine mutual fund diversity with stock liquidity, making them suited for both short- and long-term investments.
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Common ETF trading methods include swing trading, SIPs, and hedging.
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Asset allocation balances exposure across equity, debt, and commodities.
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Dollar-cost averaging enables steady, disciplined ETF investing.
Exchange-traded funds (ETFs) in India are often traded like stocks while providing the diversity of mutual funds, making them an excellent option for both short-term and long-term investing. They can be traded on stock exchanges, allowing investors to profit from both short-term price fluctuations and long-term market growth. However, unlike mutual funds, which can only be bought and sold at the end of a trading session, ETFs can be bought and sold at any time during a trading session, just like stocks.
ETFs have acquired popularity in India among both novices and experts due to their transparency, low cost, and liquidity. Understanding how to trade them efficiently may help investors manage risk and maximise returns. Here are nine tried-and-true ETF trading techniques that address various market circumstances and investing objectives. If you’re on the lookout for some ETF investing strategies to employ, here are some that can help you out.
Also, read ETF: Exchange Traded Funds Meaning, Types and Benefits here
Swing trading
This is one of the most popular ETF trading strategies that short-term traders typically use. Swing trading basically entails trying to capture the short-term price movements of an ETF. The trades under this ETF strategy are typically kept short and last only for a few days to weeks. The high liquidity that ETFs enjoy combined with the freedom to buy and sell ETF units throughout the day makes them the perfect instrument for executing such an ETF strategy.
Here’s an example of how swing trading can work for an ETF. Assume that there’s a Nifty 50 ETF that’s trading for around Rs. 80 today. You have a bullish view on the market and so, you buy 100 units of the ETF for Rs. 80 each. After around 4 to 5 trading sessions, the ETF’s price per unit goes all the way up to Rs. 90. You sell all the 100 units of the ETF at Rs. 90 each and walk away with a profit of Rs. 10 per unit, which comes up to Rs. 1,000.
Sector rotation
The sector rotation ETF strategy entails investing in currently performing sectors and then moving to others when market trends shift. This strategy enables investors to collect rewards from sectors that lead over various market cycles.
For example, if the infrastructure and capital goods sectors grow as a result of increased government expenditure, an investor may buy into ETFs that follow such sectors. When the cycle cools, they can shift their investments to more conservative sectors like FMCG or healthcare ETFs. This method is straightforward to implement and helps to mitigate risk by aligning investments with current economic trends.
On a similar note, ETFs can also be used to profit from seasonal trends. For instance, the travel and tourism industry is highly seasonal. An investor looking to use a seasonal rotation ETF strategy may choose to stay invested in an industry only for a certain period of time. Once the season blows over, the investor would cash out of that industry and invest their capital in other trending seasonal industries.
Seasonal trends
This ETF trading method focuses on capitalising on trends that occur at various periods of the year. For example, consumer and retail sector ETFs may do well over the holiday season owing to increased spending, but tourist and hospitality ETFs tend to climb during peak travel periods. Traders utilise previous performance data and market cycles to detect such tendencies and modify their ETF holdings accordingly. By observing recurrent demand trends, investors might possibly increase returns while keeping portfolio flexibility.
Asset allocation
Asset allocation is the process of utilising ETFs to diversify assets across asset classes such as stocks, debt, gold, and commodities. The idea is to balance risk and return in response to market conditions and individual risk tolerance.
For example, during turbulent periods, an investor may minimise exposure to equities ETFs while increasing holdings in debt or gold ETFs. Periodic rebalancing of ETF allocations ensures that the portfolio remains in line with financial objectives and changing market conditions. This systematic approach improves overall risk management.
Dollar Cost Averaging
Dollar-cost averaging (DCA) is an ETF investing strategy in which investors allocate a predetermined amount of money on a regular basis, regardless of market prices. This methodical approach enables them to purchase more ETF units when prices fall and fewer when prices increase, therefore averaging the total cost of ownership.
Over time, DCA reduces the impact of short-term market volatility while encouraging long-term investing discipline. It is ideal for ordinary investors who want continuous exposure to ETFs without timing the market.
Short-selling
Another hugely popular ETF trading strategy is short-selling. Short-selling entails selling an ETF for a higher price and then buying the same ETF back for a lower price. The difference between the selling price and the buying price would be the profit that you get to enjoy. That said, short-selling is one of the more riskier ETF trading strategies around, and should always be executed with the utmost caution.
Shorting an ETF is a great way to experience some returns in a market that’s on a downtrend. Here’s an example of short-selling. Assume that there’s a Nifty Bank ETF that’s trading for around Rs. 50. You have a negative outlook and expect the ETF to decline. And so, you short-sell around 100 units of the Nifty Bank ETF at Rs. 50 per unit today. If the market moves in your favour, as expected, and the price of the Nifty Bank ETF declines to around Rs. 30 per unit, you can then buy back 100 units of the Nifty Bank ETF at Rs. 30 per unit to close out your position. The profit that you get to enjoy on this trade comes up to around Rs. 2,000 (Rs. 20 x 100 units).
Hedging
Many traders and investors widely use ETFs to hedge their investment risk. Since ETFs tend to closely track a sector, an industry, or an index, they act as great instruments for hedging risk. For instance, let's assume that you have an open call position on an index like the Nifty 50. You can use a corresponding index ETF like the Nifty 50 ETF to protect your option position from downside risk. Such a hedging strategy would require you to short-sell the Nifty 50 ETF. This way, you can protect your index option position from going into losses.
Alternatively, if you have invested in a Nifty 50 ETF and wish to protect your investment from downside risk, you can also execute a reverse of the above-mentioned strategy. This would require you to either short-sell the Nifty 50 futures contract or buy put options of the Nifty 50 index. By doing so, you can effectively prevent your investment in the Nifty 50 ETF from going into losses.
Systematic Investment Plan (SIP)
Starting a Systematic Investment Plan (SIP) is one of the easiest ETF investing strategies. An SIP strategy requires you to invest a fixed amount of money at the same time each month in an ETF of your choice, irrespective of the price that the ETF is trading for. When done for a long enough period of time, you can benefit from the rupee cost averaging phenomenon, which can end up bringing your overall cost of investment down.
Through the SIP route, you get to purchase more units when the price of the ETF is low and fewer units when the price of the ETF is high. When you carry this ETF strategy out for a reasonably long period of time, the overall cost of your holdings will automatically be averaged out. All in all, rupee cost averaging is a powerful phenomenon that can help you earn significantly higher gains.
Conclusion
Exchange-traded funds give investors a flexible opportunity to participate in a variety of market areas while paying reduced fees and maintaining high liquidity. The tactics covered, ranging from systematic investment and swing trading to short-selling and hedging, demonstrate how ETFs may be tailored to various investment objectives and risk levels.
Asset allocation strategies assist investors in maintaining balance among stock, debt, and commodity ETFs, whilst dollar-cost averaging allows for consistent wealth growth through disciplined periodic investments. Furthermore, seasonal trend research enables investors to find opportunities based on predicted market trends.
Overall, knowing and implementing the right ETF investment strategy may assist investors in maximising return and successfully managing risk in the face of shifting market conditions.