At first glance an ETF may look similar to a mutual fund.  But this could not be further from the truth.

Exchange Traded Funds (ETF’s) are a simple and effective way to invest in nearly every imaginable market segment, industry, index or even the global stock market.  There is currently a huge variety of ETF’s which are designed to track the performance of any of the following:

• A stock market index – The  S&P500 (Ticker SPY)
• A commodity – Gold (Ticker GLD), Silver (Ticker AGQ)
• An Industry Global Telecoms Sector (Ticker IXP)
• Size of Stocks – Small Cap Value (Ticker VBR)
• A Country – Russia Bull (Ticker RUSL)
• A Currency – British Pound Trust (Ticker FXB)
• Futures Contracts – (Short Term S&P500 Futures (Ticker VXX)

ETF’s trade like a stock on the open market, this is beneficial as it means a good level of liquidity and lower transaction costs.  As with any financial transaction you need to know the character of the instrument you are using.

Directional Investing with ETF’s

ETF’s can also be used to trade in the direction you wish.

BULL ETF – An ETF with the word “Bull” indicated in the name means the fund will be profitable if the underlying assets increase in value.

BEAR ETF – An ETF with the word “Bear” or “Inverse” in the name indicates that if the underlying assets decrease in value you will make a profit.

Leveraged investing with ETF’s

ETF’s are also designed to provide you leverage built in.  If a fund has the term 2X or 3X in the name, it means the fund will attempt to replicate the movement of the underlying assets but magnify the gains by twice as much or three times as much.

For example, if you believe the stock market and in particular the S&P 500 is going to pull back (go down) over the next three months, you may decide to purchase the Rydex 2x Inverse S&P500 ETF (Ticker RSW).

If the market goes down 5% you should then expect to profit by 10%.  With all ETF’s the caveat is they “seek to emulate”, this means it is not always a perfect science especially with the bear market funds.  Some ETF’s do the job better than others.  Do your research.

In August 2011, the market went into a short term correction, meaning the market went down.  This table shows some of the best performing ETF’s during the market decline.

This is a list of the ETF’s with the best percentage gains over the 30 days in August 2011.  They are also filtered so that ETF’s with a capitalization of less than $200 million are excluded. This filtering helps to ensure that there is enough liquidity in the trades to enable easier entry and exit.

The ETN is similar to the ETF as it trades openly on the stock exchanges; however its underlying characteristics are different.  It is a hybrid of an ETF combined with the debt ownership of Bonds.  For example you may hold an ETN to maturity and at that point you will be eligible to receive a cash payment equivalent to the principle value of the note.