Exchange traded funds in the stock market

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Growth in ETFs

Photo Source: State Street Global Advisors

Exchange traded funds were highly uncommon, even just a few years ago. Today, you can buy any kind of ETF, including international funds, gold funds, oil funds, Dow funds, double Dow funds, and many more options. If there’s an investment, chances are you can buy it through an ETF.

Exchange traded funds have their ups and downs

ETFs have made trading and investing significantly easier for some. Rather than undergo the paperwork and logistics of opening many different trading accounts from commodities to futures to foreign exchange markets, ETFs allow people to invest in a sector or investment without opening another account. It’s as easy as buying and selling stock, which you are, except in a fund of a certain investment.

ETFs do have their downside; some funds in a particular industry are quiet about what is being held. While you might think you’re buying oil, you could very well be buying a fund of oil companies. Obviously, the shares of oil companies and oil will not perfectly correlate. That is the difficulty in finding the proper ETF; some only offer investments in companies in a particular industry rather than an actual investment in the product.

Double short and long mathematically impossible

The double short and double long positions become even more difficult to understand than regular ETFs. Consider the long term on double short or double long positions. If an index were to rise 120%, how would a double short ETF still be in existence? The fact is that double short and double long ETFs are hedges, but it’s impossible to do it perfectly as the ebb and flows of the market are far from perfect and can range in numbers larger than 50%. The gamble is that the ETF must properly hedge on the day to day; otherwise, drawdown and compound interest would ruin the chance of a truly double up or double down investment.

The ETF fees

Very few people realize that there are fees associated with ETFs much like mutual funds. It is embedded in the investor’s mind that stock market trades are fee free absent commission. Unfortunately, with ETFs, this couldn’t be further from the case, as the owner or operator of the fund receives pay for properly balancing the ETF in its particular niche.

Criticism from the government and economists

ETFs have also taken a large share of slack for their influence in the commodities markets. As investors pour from stocks to commodities, it would be obvious that the ETFs have to back their funds with the actual investment. For example, a new ETF worth $5 Billion of oil would have to purchase either $5 Billion in oil or secure the rights to buy $5 Billion in oil. This is a one time buy, as the money goes back and forth between shareholders rather than the fund administration and investors. The money goes from investor to investor in much the same way as stocks.

It would be impossible for ETFs to influence the commodities markets as much as it is alleged. The fact is that ETF purchases represent one time orders, which then are bought and sold multiple times between many people. Indeed, the initial buy is large and may impact the market.  The purchase is later isolated from the rest of the exchange, and thus, should reduce the amount of speculation on the commodities markets, whether short or long.

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