How to Use ETF as a Trading Tool

ETFs can be employed properly by investors and traders to hedge portfolios, protect assets, defer taxes, and mitigate losses during the financial debacle.

Long-term investors can accumulate capital gain over time, pay lower tax rates, carry over capital gain, and defer taxes. However, during this long process, there might be some unavoidable market pull backs, and disasters which erode capital gain. To protect profit and prevent financial market devastation, investors can purchase Bear ETFs as hedging. The higher the beta of ETFs, the more powerful they are, and the more cost effective they are.

Momentum traders and day-traders often encounter the free-riding violation.  On the other hand, the National Association of Securities Dealers (NASD) sets limitations for margin accounts, which disallow four or more round-trip day trades within any rolling five-business-day period.  To solve these issues, traders can purchase Bull ETFs when the market dips, and buy Bear ETFs when the market rises intraday.  Especially in a volatile market, traders can accumulate a profit by executing this kind of trading repeatedly within a trading day based on the flotation of the market.  Experienced traders can buy Bull ETFs on the strong sectors at dips, and buy Bear ETFs on the weak sectors during peaks.

On the other hand, in an unstable market, before the market closes, you can lock in a profit by purchasing the same amount of inverse ETFs for the same underlying securities. This will protect your profit, and avoid the big gap-down the next day.  For example, you purchased $10,000 DDM (2X Dow Jones Industrial Average Bull ETF), and gained 2% during a day. Your portfolio became $10,200.  However, to avoid breaking the violation trading rule, you were unable to sell it for a profit. Instead, you could buy $10,200 inverse DXD (2X Dow Jones Industrial Average Bear ETF). The next day, your portfolio would not see much change, regardless of the market’s up or down movement.  You could sell both of them to realize the profit you made the previous day.

However, the trading cost increases when you trade Bull ETFs and Bear ETFs at the same time.  Therefore, you should find a brokerage firm with low commissions or free trades.  This should help you avoid excess trading fees, which could present a problem if you execute the above-mentioned scenario. We are going to cover this subject in another article.