Exchange-traded funds (ETFs) are popular for traders of all levels because they are a diversified way to invest in a basket of stocks, bonds, or other assets. Although trading ETFs generally can tend to be lower risk than trading stocks, there are still some mistakes that traders commonly make. Steer clear of these top 5 mistakes:
1. Not doing your research on ETFs
ETFs can track various indexes, sectors, and assets. Before trading ETFs, it’s important to examine the ETF’s prospectus, which provides detailed information about its holdings. Look for the list of companies or assets the ETF tracks, and pay attention to the weightings of individual companies within the ETF. If there are a few dominant companies that make up a large percentage of the portfolio, this concentration can increase risk if those companies face challenges. Make sure to research the individual companies within the ETF to see if they are well-established and financially sound, or if they are struggling or speculative. When choosing ETFs to buy, consider their fees, liquidity, weightings, and tracking errors, as well as your investment goals and risk tolerance.
Imagine you’re interested in trading an ETF that tracks the technology sector with a medium-term trading strategy. Without researching its holdings, you might not realise that a big portion of the ETF is invested in tech growth stocks, which require a very long-term trading strategy to see profits. As your strategy was focused on a medium time period, this particular trade did not align with your strategy, and you likely will not make any profits.
New traders often make the mistake of overtrading, thinking that more frequent trades will lead to more profits. It often happens because of behavioural and psychological factors that can cloud judgment and lead to impulsive trading decisions. Excessive trading can lead to higher transaction costs and taxes, which can eat into your returns. Always be patient and stick to a trading strategy when trading ETFs.
Imagine you trade ETFs several times a day. You’re constantly trying to time the market perfectly without a proper strategy. However, due to inexperience and increasing transaction costs with each ETF trade, you end up losing money instead.
3. Chasing an ETF’s performance by relying on past results
It’s key to remember that past ETF performance does not indicate future results. Just because an ETF has done well in the past doesn’t mean that it will continue to do so in the future. Market performance is influenced by many factors, so it’s good to consider including fundamental and technical analysis in your strategy so you can be aware of these influences.
Imagine you decide to trade an ETF that has been performing really well over the past year. However, you overlook that a temporary market anomaly drove the ETF’s spike, and it’s likely to return to its historical average soon.
4. Ignoring diversification
Not diversifying when you trade ETFs can result in higher risks, as your portfolio becomes too dependent on the performance of a single sector, industry, or asset class. Putting your eggs in one basket can magnify losses during downturns, limit potential gains from other thriving market segments, and increase portfolio volatility. Your portfolio will be less resilient to market shocks, slowing your ability to navigate market fluctuations effectively.
Imagine you put all your money into a single commodity-focused ETF because it has been performing well recently. Unfortunately, the commodity market takes a hit, causing a big drop in the value of your investment portfolio.
5. Not using stop-loss orders
A stop-loss order is an order to sell an ETF at a specific price automatically, which can help you limit your losses if the ETF price moves against you — with a stop-loss order, you determine when you want the trade to end. For long trades (you predict the asset’s price will go up), the stop loss is set below the current market price. However, for short trades (you predict the asset’s price will go down), the stop loss is set above the current market price. This can help you to limit your losses if the ETF price moves against you. Stop-loss orders free up your time, as you don’t have to monitor your ETF positions constantly.
Imagine you decide not to set a stop-loss order on an ETF you’ve traded. The market faces a sudden economic crisis, and prices experience a huge jump. This wipes out a large chunk of your trade because you weren’t protected by a predetermined exit point.
More tips to trade ETFs
Trading ETFs offers many opportunities but also comes with risks. Whether you’re a beginner or an expert, always do your research, don’t overtrade, have a strategy, diversify, and use stop-loss orders. Here are some more tips to consider when trading ETFs:
- Get a demo account
A demo account is a trading account that allows you to practise trading without real money. On Deriv, you can sign up for a free demo account to start exploring ETF CFDs on Deriv MT5 and Deriv X. Your Deriv demo account comes preloaded with 10,000 USD in virtual funds so you can practise trading ETFs online risk-free.
- Start small first
Once you’ve learned the basics of ETF trading, you can start trading with a small amount of real money. This can help minimise your losses if you make mistakes.
- Be patient and disciplined
ETF trading is a long-term strategy. Don’t expect to get rich quickly. Instead, focus on developing a solid trading plan and sticking to it.
By educating yourself about ETFs and following the tips above, you’ll be better equipped to confidently navigate the world of ETF trading and work toward your financial goals.
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The information contained in this blog article is for educational purposes only and is not intended as financial or investment advice.
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