Exchange-traded funds (ETFs) are popular investment vehicles for retail and institutional investors alike. ETFs offer diversified exposure to various asset classes at low costs. With the right strategies, ETFs can be traded profitably to enhance overall investment returns. This article explores some proven approaches to profitable ETF trading.
Understanding ETFs and Their Trading Dynamics
An ETF is a basket of securities that tracks an underlying index or benchmark. ETFs trade on exchanges just like stocks and experience price fluctuations throughout the trading day based on supply and demand. Their share price closely follows the net asset value (NAV) of the underlying portfolio.
ETF trading involves exploiting short-term price deviations from the NAV caused by supply and demand imbalances. Large institutions use arbitrage to profit from these deviations. Retail traders can also capitalize on daily price movements using swing trading, momentum strategies and other technical analysis approaches.
Swing Trading ETFs
Swing trading involves holding a position for a few days up to several weeks to profit from short-term price moves. This strategy works well for ETF trading.
Firstly, identify an ETF with a clear directional trend, either upward or downward. Use indicators like the 20 and 50-day moving averages to determine the overall trend.
Next, look for oversold conditions in an uptrend or overbought conditions in a downtrend based on oscillators like the relative strength index (RSI). Enter a long position when the ETF is oversold or a short position when it is overbought.
Set a stop loss to limit potential losses. Book profits once the ETF reaches the upper or lower Bollinger Bands or after it has moved favorably by 3-5%. Repeat this process in the prevailing trend direction.
Trading ETFs Based on Momentum
Momentum trading involves buying securities that are rising in price and selling those that are falling. This strategy can produce quick profits with ETFs.
Screen for ETFs with strong price momentum, say over the last month or quarter. Pick ones that have outperformed their benchmark index by a significant margin.
Go long on ETFs with upward price momentum. Enter short positions for ETFs with downward momentum. Use stop losses to contain downside risk.
Use the 50-day moving average as trailing stop. Book profits when the momentum stalls and the ETF pulls back to this moving average level. Trade the next ETF displaying the most momentum.
Investing in Low Cost Franchise ETFs
Another way to diversify your ETF portfolio while minimizing risk is to invest in low cost franchise ETFs. These ETFs hold stocks of various established franchise companies across different industries like restaurants, hotels, and retail.
Popular low cost franchises like fast food chains often have steady cash flows even during economic downturns. Their stock prices tend to be less volatile as well. Investing in an ETF tracking these defensive franchises can balance out more aggressive trades in growth sectors.
One example of a low cost franchise ETF to consider is the Invesco Leisure and Entertainment ETF. The diversified business models and loyal customer bases of their holdings make them relatively stable assets for lowering portfolio risk.
Using Other Technical Strategies
ETFs can also be traded profitably using chart pattern breakouts, volume analysis and other technical strategies.
Trade chart pattern breakouts by going long when the ETF breaks out of a bullish pattern like a double bottom. Enter short trades on bearish breakdowns from head and shoulders or other patterns.
Volume analysis provides clues on emerging supply and demand trends. Rising volume on upside breakouts indicates building momentum. Declining volume on bearish breakdowns signals waning selling pressure.
Leverage technical analysis indicators like Moving Average Convergence Divergence (MACD) and Relative Strength Index (RSI) for trade entries and exits.
Managing Risk
Like any trading strategy, risk management is critical for consistent ETF profits. Use stop losses on every trade to limit the downside. Avoid excessive leverage or oversized positions that can lead to amplified losses.
Adopt prudent position sizing based on your account size and risk tolerance. Diversify across sectors and asset classes to lower portfolio volatility. Maintain exposure to non-correlated assets like gold and bonds as a hedge.
The Bottom Line
ETFs are dynamic, trading-oriented products well-suited for active trading strategies. Using swing trading, momentum and technical analysis can enhance ETF returns. However, proper risk management is vital for sustaining long-term profitability. With prudent strategies and discipline, retail investors can achieve market-beating returns with ETFs.
Featured image credit: edited from freepik
