Thursday, April 1, 2010

Stocks or Etfs

All traders, when they first come to the market are facing a simple question what to trade and what trading vehicle to choose for investments. While there could be different ambitions and some investors are coming to the market for gambling with a purpose of becoming rich in short period of time I would like to focus on simple investors who have came to the market with confusion and would prefer some not extremely big but stable increase in investments.

Majority of people are coming to the stock market without knowing anything how the market works. All they usually know is that you may invest into stock. They start to look for good stocks and very soon they become frustrated - they start to understand that in order to select a few good stocks they are required to go through hundred of stocks, compare their performance, their reports, study fundamentals, etc.

When I ask some of my friends-traders about ETFs (Exchange Traded Funds) I hear the standard answer that they became familiar with stocks and they prefer to trade stocks. My second question usually is about how he/she does analysis to see what to trade and where to trade (long or short). Now comes interesting part. I would spread their stock analysis in several steps.

Step 1: Spend 1-2 month going through hundreds of stocks from different industries. As a rule, this stage of analysis includes going through earnings and other reports, comparing stock's performance, analyzing the market sector the stocks belongs to, etc. All this ends with selection of 2-10 stocks that a trader became familiar with and considers that they are good for investments.

Step2: Subscribe to the reports, charts, quotes that cover selected stocks and could be used for further analysis on regular basis.

Step 3: Start to trade by analyzing the selected stocks on the regular basis (doing fundamental and technical analysis). In addition a stock trader continues to analyze selected industry and the whole market - you need to know where the industry and market are going do not to lose the stocks.

Doesn't it look complicated? Especially when it comes to the fundamental analysis of all the reports... People are learning in the universities how to correctly analyze and evaluate a public company. Do you think an "average Joe" has time and is able to learn all the aspects of the fundamentals and apply it on practice? I am sorry for being sarcastic, yet, I am a little bit skeptical about retail traders (including me) and their abilities to perform liable fundamental analysis of stock. Maybe you can skip fundamentals if you are day trader and trade stocks in short-term, however if you are investing your pension for longer-term you have to do fundamentals - otherwise it is not an investment but a gambling.

So, what is the solution? For me, I trade Exchange Traded Funds. There are plenty of very active ETFs: QQQQ, SPY, DIA, XLF, IWM, etc. The biggest advantage of ETF is that I do not have to do fundamental analysis - no complicated and time consuming job - all fundamentals are done by professionals who manage indexes that are tracked by ETFs. All I do is the technical analysis of indexes I trade. Index analysis is a stock, industry and market analysis at the same time. For instance when I analyze S&P 500 index, the result of the analysis could be applied to trade SPY stock (S&P 500 index tracking stock). At the same time S&P 500 is considered as a barometer of the US stock market and S&P 500 index analysis reflects sentiment on US stock market. So, tell my why should I not to trade SPY, QQQQ and other ETFs and why should I go into complicated stock analysis.

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