As the world becomes increasingly globalised, more markets are now beginning to trade ETFs. Singapore has started allowing certain companies to issue ETFs in addition to mutual funds, thus creating a whole new range of investment opportunities for investors both inside and outside of Singapore.
Exchange-traded funds are an investment vehicle that allows investors to participate in equity markets with a very low capital outlay. Despite being previously known as riskier assets, ETFs come with relatively low volatility, which is why more and more traders are turning to them for opportunities.
Main risks associated with ETF trading
While they might be considered more stable than regular stocks, ETF trading has its risks, so it would benefit traders to know what those risks are before engaging in such activities.
Time and effort spent on researching the markets
The first thing you should consider when trading ETFs is how much time and effort you want to put into researching the market. This may not always be as important as other factors such as the size of your portfolio, your financial goals and your liquidity needs, but research is always a good idea as it allows you to make more informed decisions.
Chasing high performing stocks on short notice
Since ETFs allow you to invest in an index or sector, they present opportunities for those who want to diversify their portfolios. The problem here would be that people new to ETF trading tend not to know what indices or sectors they want exposure for, resulting in unnecessary risks if the trader tries to chase high performing stocks on short notice.
A solution would be developing some expertise before engaging with broader markets by focussing on equities within their own country first.
Incorrect market timing
Some traders think of ETFs as strategies for market timing because traders can use many different options, but this may drive the trader into more risk. For example, trying to time the market by buying or selling ETFs can be difficult and costly. You’re likely to end up buying or selling at the wrong time since no one can predict the future movements of the markets with 100% certainty. Timing the market is impossible and should be avoided to minimise your risks.
ETF prices are not always in line with the underlying assets
Another thing traders need to note is that ETF prices are not always in line with the underlying assets they track, resulting in losses when positions are liquidated. For example, an ETF tracking a basket of stocks may trade at a premium or discount to its net asset value (NAV) due to supply and demand dynamics.
If you’re not aware of this, you could end up buying or selling at prices that are not reflective of the underlying assets, which will impact your profits or losses.
Subjected to leveraged trading
Finally, ETFs may be subject to leveraged trading, resulting in amplified gains or losses. Traders borrow money to trade and magnify their profits (or losses). While this can lead to higher returns if the bet pays off, it also increases the risk as there’s a greater chance of losing more money than you initially invested. To mitigate these risks, traders should be fully aware of how leveraged ETFs work before using them in their trading strategies.
While ETFs offer several advantages such as diversification and low risk, they also come with their own set of risks that need to be considered before engaging in them. It is always better to be safe than sorry, especially regarding finances.
Since many different factors affect stock prices, it’s essential to do enough research before deciding whether or not investing in these products is right for you. This will ensure that you make informed decisions with your investments and minimise unnecessary risks. Beginner traders are advised to contact a reputable online broker from Saxo Bank by visiting their website.