Larry’s note: Happy New Year traders! Here’s to another year of success and profits. And, I’m excited to share the journey with you.
Today, read on to learn why ETFs are one of my favorite financial instruments…
One of the most useful investments throughout the past several decades has been exchange-traded funds (ETFs).
ETFs have enabled buy-and-hold investors to gain exposure to a multitude of stocks (like the S&P 500 or Nasdaq), through a single holding.
However, it’s not just long-term investors that find ETFs useful. ETFs can be great for capturing shorter-term moves, like countertrends within a major trend… Or a reversal when a sector or index has run too far.
That’s why I use ETFs to trade all kinds of moves from the oil, healthcare, and gold sectors to bonds and bitcoin.
ETFs also help reduce the risk of trying to pick individual stocks.
For example, if I think retail spending is going to fall, I can short an ETF like the SPDR S&P Retail ETF (XRT). I don’t need to go through all the retail stocks to figure out the best one to short.
However, while most investors are familiar with the major index and sector ETFs, few are aware of just how many different ETFs are in the market… And just how much diversity they can offer, especially when mainstream stocks are falling.
It comes back to correlations…
When major stocks (and indices) are falling heavily, then you know most regular stocks will also be falling too. That’s because of the high degree of correlation between large and small cap stocks.
However, it doesn’t mean commodities like gold and silver will also be falling. These two commodities can often rally (or at least remain stationary) while mainstream stocks are falling.
That’s because stocks and commodities (more broadly) are driven by very different factors. And that’s why they can have very low correlations.
For stocks, company earnings, profit, and growth drive market sentiment – plus the health of the economy and stage in the economic cycle. All are major factors in determining how stocks (and the broader market) are valued and perform.
When it comes to commodities, though, supply and demand are the two driving factors. When the relationship between the two get out of whack, that’s what can cause prices to really get moving…
For example, a shortage in wheat or corn would drive up their prices irrespective of major stock indices. So, you could make money going long in ETFs for wheat (Teucrium Wheat Fund, WEAT) or corn (Teucrium Corn Fund, CORN) even when regular stocks are falling.
When stocks are rangebound or falling, being able to trade commodity ETFs can open up a whole range of trading opportunities, especially when those commodities get on a roll.
However, where commodities (and commodity ETFs) can be particularly useful is in acting as a hedge against inflation.
When consumer products are rising, typically the raw commodities used in the making of those products will be rising too.
Take food, and in particular, meat as examples. When both are increasing in price, an ETF that gives exposure to agricultural products – like the Invesco DB Agriculture Fund (DBA) – should also increase in value from the higher prices.
This also applies to base metals like copper, zinc, and aluminium. By buying an ETF that gives exposure to these raw materials – like the Invesco DB Base Metals Fund (DBB) – you can profit when their prices (and inflation) are also increasing.
Be aware, though, that not all commodity ETFs are the same. Some invest in companies that produce those raw materials, while others invest directly in commodity futures. That can have a big bearing on how those ETFs are valued by the market.
But remember, commodity-based ETFs have two key advantages: they can enable you to profit when the rest of the market is falling, and they can be used to hedge against inflation.
Editor, Trading With Larry Benedict
Have you invested in any ETFs that have paid off for you?
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