One of the best investing vehicles is exchange-traded funds, more commonly known as ETFs. They are similar to mutual funds with several important advantages. Much like mutual funds, they offer the great advantage of built-in diversification, which means downside risk is a lot lower than investing in a single stock, option, or future.
The first ETF started in 1993. It is called the SPY and is basically a fund that invests in the entire S&P500. A buyer of SPY is basically buying ALL of the S&P500 in ONE transaction. It is the most traded ETF in the world.
Another popular exchange-traded fund is the QQQ, which started in 1999. Much like buying SPY letting one own a slice of the entire S&P500, the QQQ is doing something remarkably similar, except on the top 100 stocks in the NASDAQ. An investor can buy into a single trade via ONE transaction and own a little bit of the 100 top (mostly) technology stocks!
Before we better define an ETF, let us reacquaint ourselves with a commonplace kind of investment that just about everyone has had some kind of experience with- particularly within 401Ks, IRAs, and similar: the mutual fund.
Mutual funds got their start in the early 1930s. Basically, a mutual fund is a collection of stocks, and different companies, gathered together in one basket. An investor could buy into the fund and thus own a little bit of each stock in the basket.
When you spread your money around too many stocks like that, it is called diversification. Diversification marginalizes the risk of picking the wrong stock. Instead of investing in one stock and being at great risk if something terrible happens to that company, you are in many stocks. If a mutual fund includes some of that very same stock that suffers a catastrophic fall, the impact on the fund’s value is much less. Why? Because it is just a little part of the whole.
Have you ever heard the classic Osmond’s song “One Bad Apple (Don’t Spoil the Whole Bunch)?” That title explains these funds quite well. Go ahead and picture little Donny and his brothers- sounding a lot like the Jackson Five- singing slightly different words: “One bad stock won’t spoil the whole basket girl…”
Good investing puts at least some focus on minimizing risk, so this easy diversification in funds is very appealing to the risk-averse. And since it takes only a single transaction to buy a fund- not 500 transactions to buy each stock in the S&P500- funds bring another big benefit for individual investors: simplicity… execute ONE transaction and you are done.
So what’s WRONG with mutual funds?
One big issue is that you cannot buy it and sell it during the day. You can only exit a fund at the END of the trading day (4 pm ET). That means if the overall stock market is dramatically dropping- which would mean many stocks are becoming “bad apples” in unison, including many in the fund basket- you could not bail out of these stocks until the end of the day.
Another issue with mutual funds is that their fees are usually exceedingly high. They often have multiple fees designed to enrich Wall Street at individual investors’ expense. In short, they tend to be overly expensive.
You also cannot use margin, options, or go short using mutual funds. Margin, options, and shorting will be explained in future lessons, but one key concept of the latter two is investing in some things that make money as stocks fall… to profit in bear markets. Mutual funds cannot do that… but ETFs can!
So about 60 years AFTER mutual funds were created, the markets decided to attempt to improve upon ALL of those weaknesses. The result was the creation of the exchange-traded fund (ETF). In general, ETFs retain the major benefits of mutual funds while marginalizing the weaknesses.
Suppose one wanted to have a portfolio of the 500 stocks in the S&P500. Even if you purchased just one share of each, that would be 500 transactions. If you wanted a relative balance of money in each, you could not buy only 1 share of many of those stocks. For some, you would have to buy many more shares to get an approx. even the balance of money invested in all 500. It would take a sizable investment to basically buy your own mutual-fund-like basket of all 500 stocks.
As mentioned earlier, a very popular ETF is called SPY. When you buy SPY, your money is buying a little bit of ALL of the stocks in the S&P500… the whole basket of stocks for a relatively small amount of money. How much? Like all investments, the price fluctuates… but at the time this lesson was created, you could buy a share of the SPY ETF for only $450. What does that mean? For only about $450, an investor could own a piece of all 500 of the biggest companies in America.
One of our favorite ETFs is the QQQ, which is basically buying the basket of top (mostly) technology stocks in the NASDAQ 100. In recent years, you have probably heard a term describing 7 stocks in this group. They have been named the magnificent 7:
NVIDIA (NVDA),
Tesla (TSLA),
Microsoft (MFST),
Alphabet formally known as Google (GOOG),
Apple (AAPL),
Amazon (AMZN), and
Meta formerly known as Facebook (META).
All of them are in the QQQ, along with many other great technology companies. Buy QQQ and you own the magnificent 7… PLUS another terrific 93.
ETFs are extremely versatile. One can:
buy or sell an ETF at ANY time during the day. This makes them fantastic vehicles to use for traders and investors. Want to bail out of one at 10:10 am or 1:31 pm or 3:11 pm, execute your exit order… just like selling out of a stock position.
go long (make a bullish trade) or short (make a bearish trade) in an ETF, making money if the market rises or falls. Yes, the whole market could be FALLING and- in the right kind of ETF (called an Inverse ETF)- you can be making great money on that fall.
use margin in an ETF, which means that you could put a portion down of the total money needed to buy that ETF… similar to charging something on credit but not having to actually pay for it until later.
use options on ETFs, which means you can put even less money down or create income streams.
ETF fees are generally negligible compared to mutual fund fees. And THAT is VERY IMPORTANT. Much of the fee-heavy burdens on mutual funds are removed from ETFs… which means more of the profit is kept by investors instead of siphoned away. They are rich enough: keep more of YOUR profits for YOU.
All of these attributes greatly benefit the individual trader or investor. Limitations like WHEN you can sell are stripped away. Needing a forever bull market to make money is foolish since we have never had- and will never have- a market that only goes up. The option to use some leverage allows a smaller amount of investment to go for bigger ROIs. Do you see why we like ETFs so much?
INVERSE ETFs
One of the bullets above referred to this type of ETF. Very simply, there is a small group of ETFs a bearish investor or trader can buy that are designed to profit when whatever they are tied to goes DOWN in value.
For example, we referenced SPY as a way to buy the entire S&P500, which one might do if they are bullish on the S&P500 in the near term. If one were BEARISH on the S&P500, they could consider buying the Proshares Short S&P500 (symbol SH). Again, much like how SPY increases in value when the S&P500 goes up, SH increases in value as it goes down… offering a quite easy way for a bearish investor or trader to make money by buying an ETF (which again, is just like buying a stock).
To the investor or trader, they seem just like any other ETF. Behind the scenes, they are able to make money in bearish moves because they invest in vehicles that profit from those moves. We will not dive into those details here as it is not that important to know that particular bit of “how.” The main idea to understand is that these Inverse ETFs work just like buying bull-oriented ETFs. You buy either just like buying a stock. You exit (by selling) either just like exiting a stock position.
LEVERAGED ETFs
Another appealing thing about ETFs is there is a subset of them built around baked-in leverage. Earlier, we referenced the popular QQQ as a favorite among ETF investors & traders. There is a variant ETF designed to multiply the gain or loss in a QQQ trade by approx. 2X. In other words, if a QQQ investment delivered a $1,000 gain, this 2X leveraged variant would deliver about $2,000. It is called the Proshares Ultra QQQ (symbol QLD).
If you have seen a stock chart, you know that the key line on the chart is the price of the stock. And just about any stock chart is going to show that line rising & falling over time.
At one point or another, you may have seen an audio wave drawn for you. Much like that stock chart, an audio wave shows the key line- the volume- rising & falling. It rises for louder parts of the music and falls for quieter parts. If you are looking at one while the music is playing and alter the volume, the wave lines will change with it. For example, if you crank up the volume, the wave will get larger, reflecting the louder sound.
A great way to visualize leveraged ETFs is that… like you have cranked the volume up or down a bit on gain & loss potential. If you take a:
profit on QQQ, the same investment in QLD would have increased that profit by about 2X.
loss on QQQ, the same investment in QLD would have increased that loss by about 2X.
Suppose an investor in QQQ realizes a $10K gain. The equivalent investment in QLD would yield about $20K. And it has the same “amplified” effect in a loss scenario: a $10K loss in QQQ is probably a $20K loss in QLD.
WHEN would an investor choose QLD over QQQ?
When they feel extra confident about the short-term upside of the NASDAQ 100. Relative confidence drives the choice to use leveraged trading. An investor who is:
bullish on NASDAQ may buy QQQ,
REALLY bullish might opt for QLD, or
more risk-tolerant, might choose QLD too.
Is there 3X leverage too?
Yes, there is. There is an additional subset of leveraged ETFs that aim to deliver 3X the gains (and losses) of their underlying index. For QQQ, the 3X version is the Proshares UltraPro QQQ, symbol TQQQ. Some people think of this as “triple” QQQ.
Much of what was just shared about 2X leverage is applied to 3x leverage. The “amplification” is simply “louder”… that is the upside or downside is about 3X relative to QQQ gains or losses. A $10K profit from a QQQ investment might yield about a $30K profit if the investor had chosen TQQQ instead. And a $10K loss in a QQQ investment would be about a $30K loss if the investor had used TQQQ instead.
Much of the attraction to QLD & TQQQ is driven by that amplified upside. But it is especially important to understand that amplification goes BOTH ways. If wrong about a good bullish move, such positions hurt more than they would if you were only in the QQQ. Making twice or three times as much as you hope is delightful. Losing 2 or 3 times more is painful.
While most investors are focused on the potential gain, the most important thing about being a good trader or investor is to eliminate as much risk as possible. Of course, everyone wants the gains… but good gains with limited risk will tend to do much better overall than better gains with harsher losses too. Our subscription services attempt to strike an ideal balance of risk & reward. Relative to leverage, we use a mix of investments like QQQ, QLD, and even TQQQ based on our analysis of the opportunity. If you would like to take advantage of Sal & team’s long-term experience in all market types, check them out in the Investor Recommendations menu.
Are there leveraged 2X and 3X Inverse ETFs too?
Yes, so those who feel especially bearish about most major indexes and one or more of many sectors can seek out a leverage inverse ETF to take advantage of a bearish move.
For example, the bear equivalent of the 2X leveraged QLD is QID and the equivalent of the 3X leveraged TQQQ is SQQQ. Much of what you just learned about QLD and TQQQ is applied in exactly the same with to QID and SQQQ except, they make their 2X or 3X money when the QQQ FALLS and thus lose at 2X or 3X “amplification” when the QQQ rises.
HOT TOPIC ETFs
New ETFs tend to be created to take advantage of hot topics driving markets. As this is written, Artificial Intelligence is a very hot market topic and there are already AI ETFs for investors & traders to buy & sell.
Picking an individual AI stock that then goes up by 1000% is not easy. There will be big winners and big losers in individual AI stocks. Rather than risk a lot of money on one stock, the diversified basket of AI stocks in an AI ETF can let you jump on the AI train with less risk should any one stock in the basket of stocks suffer a big fall.
As this topic began, we end with the same key concept:
funds offer a way to buy many stocks in one trade, and enjoy risk-reducing diversification without having to ignore hot trending opportunities like technology or AI stocks or whatever proves to be the “next big thing.”
Instead of mutual funds and all of their baggage & negatives, ETFs offer MUCH of the same positives with many advantages… particularly in how one can make and KEEP more money made with them while enjoying the reduced risk exposure that comes with diversification.
We all want to make more money with less risk. That is a core goal of this website and our business. Let us help you do exactly that.
One of the best investing vehicles is exchange-traded funds, more commonly known as ETFs. They are similar to mutual funds with several important advantages. Much like mutual funds, they offer the great advantage of built-in diversification, which means downside risk is a lot lower than investing in a single stock, option, or future.
The first ETF started in 1993. It is called the SPY and is basically a fund that invests in the entire S&P500. A buyer of SPY is basically buying ALL of the S&P500 in ONE transaction. It is the most traded ETF in the world.
Another popular exchange-traded fund is the QQQ, which started in 1999. Much like buying SPY letting one own a slice of the entire S&P500, the QQQ is doing something remarkably similar, except on the top 100 stocks in the NASDAQ. An investor can buy into a single trade via ONE transaction and own a little bit of the 100 top (mostly) technology stocks!
Before we better define an ETF, let us reacquaint ourselves with a commonplace kind of investment that just about everyone has had some kind of experience with- particularly within 401Ks, IRAs, and similar: the mutual fund.
Mutual funds got their start in the early 1930s. Basically, a mutual fund is a collection of stocks, and different companies, gathered together in one basket. An investor could buy into the fund and thus own a little bit of each stock in the basket.
When you spread your money around too many stocks like that, it is called diversification. Diversification marginalizes the risk of picking the wrong stock. Instead of investing in one stock and being at great risk if something terrible happens to that company, you are in many stocks. If a mutual fund includes some of that very same stock that suffers a catastrophic fall, the impact on the fund’s value is much less. Why? Because it is just a little part of the whole.
Have you ever heard the classic Osmond’s song “One Bad Apple (Don’t Spoil the Whole Bunch)?” That title explains these funds quite well. Go ahead and picture little Donny and his brothers- sounding a lot like the Jackson Five- singing slightly different words: “One bad stock won’t spoil the whole basket girl…”
Good investing puts at least some focus on minimizing risk, so this easy diversification in funds is very appealing to the risk-averse. And since it takes only a single transaction to buy a fund- not 500 transactions to buy each stock in the S&P500- funds bring another big benefit for individual investors: simplicity… execute ONE transaction and you are done.
So what’s WRONG with mutual funds?
So about 60 years AFTER mutual funds were created, the markets decided to attempt to improve upon ALL of those weaknesses. The result was the creation of the exchange-traded fund (ETF). In general, ETFs retain the major benefits of mutual funds while marginalizing the weaknesses.
Suppose one wanted to have a portfolio of the 500 stocks in the S&P500. Even if you purchased just one share of each, that would be 500 transactions. If you wanted a relative balance of money in each, you could not buy only 1 share of many of those stocks. For some, you would have to buy many more shares to get an approx. even the balance of money invested in all 500. It would take a sizable investment to basically buy your own mutual-fund-like basket of all 500 stocks.
As mentioned earlier, a very popular ETF is called SPY. When you buy SPY, your money is buying a little bit of ALL of the stocks in the S&P500… the whole basket of stocks for a relatively small amount of money. How much? Like all investments, the price fluctuates… but at the time this lesson was created, you could buy a share of the SPY ETF for only $450. What does that mean? For only about $450, an investor could own a piece of all 500 of the biggest companies in America.
One of our favorite ETFs is the QQQ, which is basically buying the basket of top (mostly) technology stocks in the NASDAQ 100. In recent years, you have probably heard a term describing 7 stocks in this group. They have been named the magnificent 7:
All of them are in the QQQ, along with many other great technology companies. Buy QQQ and you own the magnificent 7… PLUS another terrific 93.
ETFs are extremely versatile. One can:
ETF fees are generally negligible compared to mutual fund fees. And THAT is VERY IMPORTANT. Much of the fee-heavy burdens on mutual funds are removed from ETFs… which means more of the profit is kept by investors instead of siphoned away. They are rich enough: keep more of YOUR profits for YOU.
All of these attributes greatly benefit the individual trader or investor. Limitations like WHEN you can sell are stripped away. Needing a forever bull market to make money is foolish since we have never had- and will never have- a market that only goes up. The option to use some leverage allows a smaller amount of investment to go for bigger ROIs. Do you see why we like ETFs so much?
INVERSE ETFs
One of the bullets above referred to this type of ETF. Very simply, there is a small group of ETFs a bearish investor or trader can buy that are designed to profit when whatever they are tied to goes DOWN in value.
For example, we referenced SPY as a way to buy the entire S&P500, which one might do if they are bullish on the S&P500 in the near term. If one were BEARISH on the S&P500, they could consider buying the Proshares Short S&P500 (symbol SH). Again, much like how SPY increases in value when the S&P500 goes up, SH increases in value as it goes down… offering a quite easy way for a bearish investor or trader to make money by buying an ETF (which again, is just like buying a stock).
To the investor or trader, they seem just like any other ETF. Behind the scenes, they are able to make money in bearish moves because they invest in vehicles that profit from those moves. We will not dive into those details here as it is not that important to know that particular bit of “how.” The main idea to understand is that these Inverse ETFs work just like buying bull-oriented ETFs. You buy either just like buying a stock. You exit (by selling) either just like exiting a stock position.
LEVERAGED ETFs
Another appealing thing about ETFs is there is a subset of them built around baked-in leverage. Earlier, we referenced the popular QQQ as a favorite among ETF investors & traders. There is a variant ETF designed to multiply the gain or loss in a QQQ trade by approx. 2X. In other words, if a QQQ investment delivered a $1,000 gain, this 2X leveraged variant would deliver about $2,000. It is called the Proshares Ultra QQQ (symbol QLD).
If you have seen a stock chart, you know that the key line on the chart is the price of the stock. And just about any stock chart is going to show that line rising & falling over time.
At one point or another, you may have seen an audio wave drawn for you. Much like that stock chart, an audio wave shows the key line- the volume- rising & falling. It rises for louder parts of the music and falls for quieter parts. If you are looking at one while the music is playing and alter the volume, the wave lines will change with it. For example, if you crank up the volume, the wave will get larger, reflecting the louder sound.
A great way to visualize leveraged ETFs is that… like you have cranked the volume up or down a bit on gain & loss potential. If you take a:
Suppose an investor in QQQ realizes a $10K gain. The equivalent investment in QLD would yield about $20K. And it has the same “amplified” effect in a loss scenario: a $10K loss in QQQ is probably a $20K loss in QLD.
WHEN would an investor choose QLD over QQQ?
When they feel extra confident about the short-term upside of the NASDAQ 100. Relative confidence drives the choice to use leveraged trading. An investor who is:
Is there 3X leverage too?
Yes, there is. There is an additional subset of leveraged ETFs that aim to deliver 3X the gains (and losses) of their underlying index. For QQQ, the 3X version is the Proshares UltraPro QQQ, symbol TQQQ. Some people think of this as “triple” QQQ.
Much of what was just shared about 2X leverage is applied to 3x leverage. The “amplification” is simply “louder”… that is the upside or downside is about 3X relative to QQQ gains or losses. A $10K profit from a QQQ investment might yield about a $30K profit if the investor had chosen TQQQ instead. And a $10K loss in a QQQ investment would be about a $30K loss if the investor had used TQQQ instead.
Much of the attraction to QLD & TQQQ is driven by that amplified upside. But it is especially important to understand that amplification goes BOTH ways. If wrong about a good bullish move, such positions hurt more than they would if you were only in the QQQ. Making twice or three times as much as you hope is delightful. Losing 2 or 3 times more is painful.
While most investors are focused on the potential gain, the most important thing about being a good trader or investor is to eliminate as much risk as possible. Of course, everyone wants the gains… but good gains with limited risk will tend to do much better overall than better gains with harsher losses too. Our subscription services attempt to strike an ideal balance of risk & reward. Relative to leverage, we use a mix of investments like QQQ, QLD, and even TQQQ based on our analysis of the opportunity. If you would like to take advantage of Sal & team’s long-term experience in all market types, check them out in the Investor Recommendations menu.
Are there leveraged 2X and 3X Inverse ETFs too?
Yes, so those who feel especially bearish about most major indexes and one or more of many sectors can seek out a leverage inverse ETF to take advantage of a bearish move.
For example, the bear equivalent of the 2X leveraged QLD is QID and the equivalent of the 3X leveraged TQQQ is SQQQ. Much of what you just learned about QLD and TQQQ is applied in exactly the same with to QID and SQQQ except, they make their 2X or 3X money when the QQQ FALLS and thus lose at 2X or 3X “amplification” when the QQQ rises.
HOT TOPIC ETFs
New ETFs tend to be created to take advantage of hot topics driving markets. As this is written, Artificial Intelligence is a very hot market topic and there are already AI ETFs for investors & traders to buy & sell.
Picking an individual AI stock that then goes up by 1000% is not easy. There will be big winners and big losers in individual AI stocks. Rather than risk a lot of money on one stock, the diversified basket of AI stocks in an AI ETF can let you jump on the AI train with less risk should any one stock in the basket of stocks suffer a big fall.
As this topic began, we end with the same key concept:
funds offer a way to buy many stocks in one trade, and enjoy risk-reducing diversification without having to ignore hot trending opportunities like technology or AI stocks or whatever proves to be the “next big thing.”
Instead of mutual funds and all of their baggage & negatives, ETFs offer MUCH of the same positives with many advantages… particularly in how one can make and KEEP more money made with them while enjoying the reduced risk exposure that comes with diversification.
We all want to make more money with less risk. That is a core goal of this website and our business. Let us help you do exactly that.
Question or Comment?