We may encounter many popular trading techniques when trading in both traditional and cryptocurrency financial markets and learn that sometimes using one method will not represent the success of a successful trader or an investor.
We studied the fundamentals of Exchange-Traded Funds (ETF) in our previous article and learnt that ETFs are especially suitable for beginners because of its myriad of benefits like portfolio diversification. Today, we are looking at the various types of strategies ideal for any form of trading or investment, more so for ETFs.
Strategies
Hedging
In a substantial portfolio, maybe obtained as a result of an inheritance, a beginner may sometimes need to hedge or protect against downside risk.
Assume you have inherited a massive U.S. blue-chip portfolio and are nervous about the possibility of a significant fall in U.S. equities. The buying of put options is one alternative. However, most beginners are not familiar with option trading strategies; initiating a short position in broad market ETFs such as the SPDR S&P 500 (SPY) or the SPDR Dow Jones Industrial Average ETF is an alternative strategy (DIA).
Your blue-chip stock exposure will be effectively hedged as losses in your portfolio will be offset by gains in the short ETF position if the market declines as predicted. Notice that your gains will also be capped if the market progresses, as gains in your portfolio would be offset by losses in the short ETF role. Nevertheless, ETFs provide a reasonably simple and successful method of hedging for beginners.
Asset Allocation
A vital investment tool is asset allocation, which means allocating a portion of a portfolio to various asset categories, such as stocks, shares, commodities and cash, for diversification purposes. The low investment threshold for most ETFs, usually as little as $50 per month, makes it easy for a novice to adopt a simple asset allocation strategy depending on his or her investment time horizon and risk tolerance.
Swing Trading
Swing trades aim to take advantage of large price fluctuations or other instruments, such as currencies or commodities. Unlike day trading, which is rarely left open immediately, they can take anything from a few days to a few weeks to sort out.
ETFs’ characteristics are their diversification and tight bid/ask spreads that make them ideal for swing trading. Furthermore, since ETFs are available for a wide variety of sectors and many different investment groups, a novice may choose to trade an ETF based on an industry or asset class where they have some unique experience or knowledge.
Since ETFs are usually stock or other asset baskets, they do not show the same degree of upward price movement as a single stock in a bull market. Their diversification often makes them less vulnerable to a significant downward step than single stocks. This offers some defense, which is an essential consideration for beginners, against capital erosion.
Short Selling
For most investors, short selling, the sale of a borrowed security or financial instrument, is typically a pretty risky endeavor and thus not something most beginners should pursue.
Because of the lower risk of a short squeeze, short selling through ETFs is preferable to shorting individual stocks, a trading scenario in which a significantly shortened security or product spikes higher, as well as the considerably lower borrowing expense (compared with the cost incurred in trying to short a stock with high short interest). For a beginner, these risk-mitigation factors are essential.
Short selling through ETFs also helps a trader to take advantage of a broad theme of investment. Thus, through the iShares MSCI Emerging Markets ETF, an experienced beginner (if such an oxymoron exists) is familiar with the risks of shorting and wants to initiate a short position in the emerging markets might do so (EEM).
Dollar-Cost Averaging
Finally, dollar-cost averaging (DCA) is the practice of purchasing an asset on a daily schedule for a certain fixed-dollar sum, regardless of the asset’s changing cost and is the most popular strategy amongst young investors. Beginner investors are usually young individuals who have been in the workforce for a year or two and have a steady income every month from which they can save a little.
For beginners, there are two significant benefits of such periodic investing. The first is that the savings process imparts a specific discipline. It makes excellent sense to pay yourself first, as many financial planners advise, which you accomplish by saving regularly.
Secondly, by investing a fixed-dollar amount in an ETF monthly, you accumulate more units when the price is low and when there are fewer units when the price of the ETF goes up – This averages out the cost of your holdings. This technique will pay off lucratively over time as long as one sticks to the discipline.
Closing Thoughts
Amid unprecedented strains on the global economy at this time of Covid-19, you will still find opportunities in any primary asset class with the right strategies. The bottom line is still diversification, whether you are a beginner or an expert in the financial markets.
For related articles, read DigiFinex Academy.
