Finding Right ETFs for Trading, Choosing Right ETF to Invest

Friday, October 17, 2008

Finding Right ETFs for Trading

Exchange Traded Funds (ETFs) are still considered as new comers of financial market, and new types of ETFs, with different underlying indexes and instruments, are coming up. Now there is more than 600 ETFs available for trading and all of them is not suitable for all traders. Traders should select them according to their profit expectations, trading knowledge and trading preferences. Here are some factors which help in evaluation of ETFs.

Underlying asset or index: This varies considerably, many ETFs track major indices, some track foreign exchange indices and some others track specific sector/industry. Generally it is good to trade ETFs that track major, known and broad index.
Asset level: Evaluate the total value of the underlying asset that the ETF holding. It is better to avoid ETFs which falls below a certain asset level (eg: $10 million). ETFs having lower asset value are not so preferred by traders and thus have low liquidity.
Liquidity: This can be measured from daily trading volume. There are many ETFs which have daily activity of millions of shares and there are also many ETFs which are rarely traded. It is better to choose an ETF with fair/higher amount of liquidity and tight ask and bid spreads.
Tracking Error: Is the measurement of how closely the underlying index is tracked. ETFs which minimal tracking errors are considered better.
Market Leader: Usually ETFs which are first of that section/market have better chance of being the market leader as traders generally prefer them over ETFs which are imitations of the first.