Fundamental Terms and Concepts of ETFs

Exchange-traded funds (ETFs) are a type of pooled investment security. When you trade an ETF, you get a collection of stocks, bonds, and other securities that can be bought and sold during market hours, undergoing the same price changes throughout the day as stocks.

What Is an ETF?

An Exchange-Traded Fund (ETF) provides broad exposure by diversifying investments across multiple assets, which helps reduce the risk of any single stock's price decline. Similar to mutual funds, ETFs track specific indexes, commodities, or sectors. However, unlike mutual funds, ETFs are traded on stock exchanges, allowing investors to buy and sell them throughout the trading day, just like individual stocks. Here are some basic ETF terms you should know:

1. Index
An index is a collection of securities that represents a specific market or a segment of it. It tracks the performance of that market or submarket and is often used as a benchmark by fund managers or investors to measure overall market trends. Common examples of indexes include the S&P 500, also known as the USA 500, and the Dow Jones Industrial Average.

2. Asset Allocation
Asset allocation is an investment strategy designed to manage risk and reward by distributing investments across various asset classes, such as cash, bonds, stocks, and real estate. This approach aims to balance risk levels and potential returns by diversifying the investment portfolio.

3. Diversification
Diversification builds on asset allocation by selecting a mix of individual stocks and bonds and determining the amount to invest in each. A well-diversified portfolio can mitigate losses from underperforming investments, balancing potential profits across different assets. The degree of diversification depends on the investor's risk tolerance and return expectations.

4. Physical and Synthetic ETFs
Physical ETFs track their target index by holding the actual underlying securities or a portion of them. Synthetic ETFs, however, do not invest directly in the assets but use financial derivatives to gain exposure to hard-to-access instruments like commodities. For example, a synthetic ETF might use oil futures contracts to track the price of crude oil, allowing investors to gain exposure without physically owning the commodity.

5. Beta Funds
Beta measures an investment's volatility relative to the broader market, often using the S&P 500 index as a benchmark. A beta of 1 indicates that the investment's price moves in line with the market. For instance, an investment with a beta of 1 would likely experience a 1% change in price for every 1% change in the S&P 500.

6. Liquidity
Liquidity refers to how quickly and easily a security or asset can be converted into cash without significantly affecting its market price. High liquidity means lower transaction costs and easier trading, while low liquidity can lead to higher costs and difficulties in executing trades.

7. Minimum Volatility
Minimum volatility is a strategy focused on reducing the impact of market fluctuations on an investment portfolio. This approach aims to mitigate risks associated with interest rate changes, stock price volatility, and currency movements, offering investors returns that are close to market levels with potentially lower risk.

8. Yield
Yield represents the return on an investment, expressed as a percentage of the invested amount. For example, an ETF priced at $100 with a $5 dividend would have a yield of 5%.

9. High-Yield Bonds
High-yield bonds are issued by companies with lower credit ratings and offer higher returns to compensate for the increased risk. Investors looking to boost their portfolio’s returns may consider these bonds, which typically come with higher yields due to their riskier nature.

When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss.

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.