How to Construct an ETF Portfolio for Trading - dummies

How to Construct an ETF Portfolio for Trading

By Michael Griffis, Lita Epstein

Constructing an ETF portfolio for trading is not much different than constructing a stock-based portfolio. The only difference is that you use ETFs for building your trading system rather than stocks.

ETFs can be created from trading tools besides domestic stocks, such as commodities and currencies. If you’re more adventurous and understand the risks involved in other types of trading vehicles and strategies, you may want to check out some of the following ETFs.

International trading with ETFs

If you want to add an international component to your trading strategy, ETFs make that much easier. You don’t have to worry about the difficulties of researching international stocks individually. You can just research the ETFs for the countries you want to add to your strategy.

Be careful, though, because now you’re adding in the market risks of international trading, which include political risks (the politics of every country whose stocks are in the ETF) and currency risks (the fluctuation of currency values among the countries represented in the ETF).

Commodities and ETFs

You can also decide to add commodities to your trading mix. ETFs with commodities baskets or single commodities are available. But this type of trading is different, so be sure to study the basics of commodity trading before you start risking your money. If the topic interests you, get a copy of Commodities Trading For Dummies, by Amine Bouchentouf (Wiley), before you get your feet wet.

Currency trading and ETFs

Even currency trading can be done using ETFs. Most major currencies have an ETF that can be traded with a basket of assets in that currency. You can find out more information about currency trading in Currency Trading For Dummies, by Brian Dolan (Wiley).

Leveraged ETFs

Leveraged ETFs amplify the returns of a particular index by using financial derivatives and debt. A 2:1 leverage fund means that every dollar invested by a trader in the fund is matched with a dollar of debt. Theoretically, if all goes well, the leveraged ETF returns double. So if the index upon which the leverage ETF is based goes up 1 percent, the ETF’s value goes up by 2 percent.

That increase may sound great to you, but the opposite is also true. If the ETF makes the wrong bet on the trend and the index goes down 1 percent, the ETF value goes down by 2 percent. Leveraged ETFs definitely take a strategy for minimizing risks and make it instead a strategy that could compound the risks you take.

Inverse ETFs

If you want to hedge your bets and invest in an ETF that will move in the opposite direction of the index, then choose an inverse ETF. For example, the ProSharesShort QQQ ETF (AMEX:PSQ) is the one to choose if you expect a downturn in the NASDAQ 100 Index.

So if you’re expecting the underlying index to go up but you want an insurance policy in case the index goes down, you may choose to balance your trading portfolio with an inverse ETF for the sector you’re betting on.