How to trade ETFs

Introduction

Exchange-Traded Funds (ETFs) first appeared in Canada in 1990. From the beginning, these pooled investment funds provided a simple way for investors to track the performance of an index. Since then, they have grown to become one of the most important products for retail investors. Every day, an enormous volume of ETFs are traded by investors looking to replicate the performance of different indices at low cost. As these products have grown in popularity, banks and investment houses have expanded their range, offering new ETF products and allowing investors access to niche markets. When trading an ETF, you are investing in a pooled fund, where the issuer owns the underlying shares, bonds, or commodities. ETF traders share in the price action of the underlying index, and they can buy or sell their ETF shares like any other stock, with high-volume intraday markets for the largest ETFs.

“ETFs trade exactly like stocks, and are listed on the same exchanges”

What are ETFs?

ETFs are shared investment vehicles. To create an ETF, an investment manager buys a basket of shares, and issues a fund based on this basket. By offering outside investors the opportunity to buy shares in their fund, which is based on an index such as the S&P500, retail investors can trade their chosen index indirectly. The ETF investor does not own the underlying shares, but since the fund tracks the price action of the index, so does the value of their investment. ETFs are available on stocks, which is by far the most important ETF market, but also for bonds and commodities.

How are ETFs different from passive mutual funds?

ETFs are very similar to passive mutual funds, with the difference that they trade on an exchange, like stocks. This means they can be bought and sold intraday, whereas mutual funds are settled outside of market hours. Passive mutual funds or index funds sometimes have redemption fees, and it can take several days to exit a position. That means they are more suited to long-term, buy and hold investing. ETFs are also effective for buy and hold strategies, but their added flexibility means they can also be used by day traders or short-term position takers.

How are ETFs different from CFDs?

Like CFDs on indices, ETFs allow traders to share in the price action of an index without owning the underlying asset. However, they have significant differences from CFDs. In a CFD contract, neither the issuer not the buyer owns the underlying asset. In an ETF, the issuer owns the underlying stocks, bonds or other assets that make up the index. This means ETFs receive dividends, which can be either distributed to investors as cash or reinvested automatically into the fund.

What is ETF trading? 

ETFs trade exactly like stocks, and are listed on the same exchanges. For example, the most traded ETF worldwide, and oldest ETF is in the USA, is the SPDR S&P 500 ETF Trust. This fund is issued by State Street Global Advisors and trades on the New York Stock Exchange. Similar funds are listed on exchanges worldwide. ETFs are one of the main ways retail investors can share in the overall performance of headline indices such as the FTSE100 or the CAC40.

Types of ETF

Like index funds, ETFs are divided into categories based on the stocks they include. The main criteria are market capitalisation and geography: the S&P500 includes the top 500 American companies by market capitalisation, and the FTSE100 the largest 100 British companies. ETFs exist for all the main stock indices, and are also available for fixed income products, as well as commodities including precious metals. ETFs on commodities are a popular way for retail investors to share in price action of physical commodities without taking ownership of the underlying asset.

Why are ETFs important?

ETFs are important because they are enormously popular. In 2024, ETFs accounted for 13% of total AUM for US stock markets, and 30% of daily trading volume. This share has steadily grown since their invention in the 1990s. For individual retail investors, ETFs are one of the simplest and most cost-effective ways to access global financial markets, with lower fees than actively managed funds. The rise of ETFs coincided with growing criticism of active investment management by financial analysts, with many mutual fund managers failing to beat their benchmarks. Some investors have concluded that trying to beat the index simply isn’t worth it, and instead put their funds into passive ETFs.

Active versus passive investing

The competition between active and passive investment strategies is an old one. Since Vanguard first launched in 1975, the passive mutual fund house has grown to be one of the world’s largest financial institutions. Charging far lower fees than active managers, passive investment funds do not try to beat a benchmark index but replicate it, owning a basket of shares in proportion to their weight in the index. Though some investment managers beat the market for years at a time, analysts are sceptical about the possibility of long-term exceptional returns. Given the long-term nature of typical investment goals, the fee difference means passive investment strategies, in most cases at least, perform better.

Smart beta: the best of both worlds?

Many traders and investors are not totally satisfied with the arguments made for passive investing. Although it is difficult to beat the market as a giant investment manager, some smaller funds and individual traders undeniably do. The most compelling part of passive investing is its cost, and smart beta is an investment strategy that tries to combine the low costs of passive management with the enhanced potential returns of active. Smart beta funds use specialised indices based around an investment theme, such as value, and track a bundle of stocks that meet these requirements. For example, a value investing theme might track an index of undervalued stocks with a lower-than-average P/E ratio. ETFs are the most common way to do this, and they combine the low fees of a passive fund with the targeted investment strategy of active management.

How to trade ETFs

To trade ETFs, you will need a trading account. Consider running a demo account at first, so you can familiarise yourself with the trading platform and market price action before risking your capital. Remember, ETFs are available in multiple markets, and although they trade on stock exchanges fixed income and commodity ETFs also exist. Retail investors should be careful that they understand the purpose of the fund – some ETFs have very specialised purposes and are aimed at traders looking to hedge or access complex risks. For example, leveraged ETFs that replicate two or three times the daily move in a certain index are advanced trading tools and not suitable for most retail investors. When looking at the name and terms of an ETF, make sure you understand the underlying index and are comfortable being exposed to its price action.

Conclusion

ETFs are popular for a reason. They are low cost, easy to trade, and allow access to financial markets without taking ownership of the underlying asset. ETF issuers are active in all geographies and in all financial markets, including niche commodities or small stock markets, although less liquid ETFs may have higher fees. Trading ETFs is similar to index CFD trading, but more geared towards long-term investment, and has some advantageous features such as reinvestment or payout of dividends. For investors looking to access the stock market, but who want to avoid over-concentration in single stocks, ETFs are a logical and effective way to trade.

FAQs