A Beginners Guide to Exchange Traded Funds

ETFs or Exchange Traded Funds are open ended investment companies that are designed to track specific markets including global stock indices, commodities and metals. They have massively grown in popularity in recent years partly due to the simplicity of them. Some brokers offer the option to trade these exchange traded funds on margin giving the opportunity for greater gains, but also greater losses. Most Exchange traded funds have the option of going long or short.

There are many advantages associated with ETFs. They are generally very cost effective to hold for the longer term, unlike many CFDs. Annual fees vary from around 0.2% to 2% per year. They are very easy to buy and sell and require no knowledge of the futures markets like when trading index futures.

Like all forms of investing, ETFs are no different when it comes to risk. Your investment will fluctuate and can go down as well as up, so a good understanding of the underlying security is essential. It is also good to understand exactly how the fund is planning to track the underlying security. Many of the index ETFs buy the individual shares so should track the index closely. Many of the metal ETFs actually buy the metal and store it. However, some other commodities are not easy to buy and store, like oil. Most Oil ETFs actually buy oil futures to track oil which means the fund will be subjected to the risk of contango and backwardisation in the futures market. For the first half of 2007 oil futures were in strong contango and as a result the oil ETFs tracked oil very poorly. It is not essential to learn about the futures market to invest with ETFs, but it is important to understand that they are not guaranteed to track the underlying security.

Peter Marsden currently runs a forex site and blog at http://www.forexpm.com

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