There’s a lot of buzz around ETFs (Exchange-Traded Funds). They’ve been touted as the future of investing and are growing in popularity. But how do you analyze an ETF to make sure it’s right for your portfolio? It can seem like there are many moving parts with these investments, but if you understand them, they’re really not that complicated. In this article we’ll explain some basic principles about ETFs, then show how you can use them to make informed decisions about your investments.
Asset Class
The first thing to understand about ETFs is that they are a type of fund that tracks an index, a commodity, bonds, or a basket of assets. ETFs are traded like stocks on the stock market. They’re a great way to get diversified exposure to various asset classes without having to buy every single security involved in that particular asset class yourself.
One of the best things about ETFs is that they’re very easy to understand. All you need to know is what type of asset class the ETF tracks, and you can invest in it using any brokerage account.
The best part about ETFs is that they’re very cost efficient. You don’t have to pay high fees for actively managed funds, and you can also avoid mutual fund sales charges. The only fee that you’ll pay is the small expense ratio charged by the fund’s manager. This is usually less than 0.20% per year, which means that ETFs are much cheaper than mutual funds or individual stocks in most cases.
Net Asset Value (NAV)
The net asset value of the fund is known as the NAV, which is calculated by dividing the total value of all assets held by a fund by its number of shares outstanding. The NAV represents the dollar amount you would get if you liquidated all holdings of an ETF at market value.
The price of an ETF is the sum of the value of its holdings plus any accrued interest and dividends. The fund’s price fluctuates throughout the day with the price movements of its underlying holdings.
The price of an ETF is determined by supply and demand. The more people who want to buy the fund, the higher its price will go. Similarly, if there are more sellers than buyers, then the price will decrease until those interested in buying outsell those wishing to sell. ETFs can be bought and sold through a brokerage account like any other security.
Liquidity
The ability to trade an asset without affecting its price is called liquidity. Liquidity is important for ETFs because it allows you to buy and sell shares at fair value. The liquidity of an ETF can be measured by its bid/ask spread.
The bid-ask spread refers to the difference between the price at which someone wants to buy shares of an ETF and the price at which someone wants to sell those same shares. For example, a fund with a $5 bid/ask would be trading at $5.01/$4.99 if you wanted to buy or sell one share respectively (assuming no other factors like market volatility).
The lower the bid/ask spread, the more liquid an ETF is. Generally speaking, the more liquid an ETF, the better. Liquidity allows you to make trades without affecting price and helps ensure that you are getting a fair price for your shares.
For example, if you wanted to sell your shares of an ETF and there was no bid/ask spread, you would sell them at the same price as someone who wanted to buy those same shares. However, if there were a bid-ask spread, then selling your shares could affect the price that someone else would have paid for them if they decided to buy.
Technical Indicators
Technical indicators are the complex-looking lines found above, below, or over the top of prices on a stock chart. These lines are the results of mathematical formulas plotted over the same time frame as the chart, and they provide key insights into market timing.
For example: The Relative Strength Indicator (RSI) measures momentum by comparing upward moves to downward ones; if it’s above 70% and rising, you may have time to buy before a correction; when it falls below 30%, sell immediately because your investment is about to tank.
The Support/Resistance levels (S/R) show where buyers have failed at certain price points in the past—but if that price point is broken successfully with sufficient volume then we will see S/Rs move higher into new territory.
The Moving Average Convergence/Divergence (MACD) is a trend-following momentum indicator that compares the difference between two moving averages. When this difference is above 0, it means that the faster moving average (the line with the “tails”) is above the slower moving average (the middle line). This shows that price is trending upward; when it falls below 0, then price is trending downward.
The Relative Strength Index (RSI) is a momentum indicator that measures the magnitude of recent price movements. It oscillates between 0 and 100, with an increase in price resulting in higher values, while a decrease in price causes lower values. The RSI is quite useful because it helps traders to identify when it may be time to buy or sell an investment by analyzing the strength of its recent performance.
ETFs might not be as complex as they seem.
ETFs might be more simplistic than they appear at first glance.
An ETF is simply a basket of stocks or bonds. It’s traded like a stock, with its own ticker symbol and price movement, but it can have hundreds of holdings instead of just one. And it has an underlying NAV—a net asset value that represents the sum of all of its assets divided by how many shares are outstanding. When you buy or sell an ETF, you affect that NAV and thus change the prices for every individual security held in the fund relative to what it would be if there were no investor trading activity happening around this specific ETF instrument.
In short, ETFs are a way for investors to diversify their portfolios without having to purchase individual stocks or bonds.
It’s important to note that while ETFs are often analyzed by looking at their assets, NAV, and liquidity—the three main components of an ETF’s value—there are many other factors that can affect the performance of an individual fund. For example, the technical indicators used by chartists (people who study charts) are also important when analyzing an ETF. In short, there is no single correct way to analyze an ETF; however, there are some general guidelines that should be followed if you want your analysis to be as accurate as possible.
