View: Is It Better To Trade ETFs Or Individual Stocks? « Trading Strategies

If you are an active trader of the stock markets, one question that may be on your mind is whether it is better to trade ETFs (exchange-traded funds) or individual stocks. Since both instruments have their distinct individual advantages, you may have a preference for one or the other. In this article, I explain why my personal trading strategy relies on trading both ETFs and individual stocks, with my actual ratio of ETF holdings versus stock holdings being based on technical stock market conditions.

If you have any experience in online trading, you probably already have at least a basic understanding of the similarities and differences between ETFs and individual stocks (click here if you don’t). Overall, ETF trading is extremely similar to stock trading. Yet, despite the similarities of these two popular trading vehicles, there are certain times when it is better to focus your trading more exclusively on trading ETFs OR individual stocks. Here is why…

ETFs – The double-edged sword of diversification

One major benefit of buying an ETF is the diversification that comes from purchasing an entire index of stocks (or other instruments), rather than just shares of an individual company. This diversification automatically reduces the risk of buying any ETF, as compared to an individual stock.

If, for example, you wake up in the morning to read news that your favorite company got caught with its hands in the cookie jar, shares of the individual stock will likely plunge when the market opens that day. In extreme cases, a stock can instantly get cut in half (or worse). However, if you only owned an ETF that held a small percentage of that same stock in its portfolio, rather than owning the stock itself, the share price of the ETF would likely drop that day as well, but by a much smaller percentage.

On the other hand, it is important to realize that diversification has the disadvantage of limiting potential upside gains in strongly uptrending bull markets. This is because shares of leading individual growth stocks will nearly always outperform the percentage gains of related ETFs over any given day, month, or year in a bullish market environment. For this reason, I trade more individual stocks than ETFs in strongly uptrending or overly bullish markets.

Profiting in range-bound or choppy stock markets with ETFs

Although stock trading can be more profitable than ETF trading in bull markets, the reality is that most global stock markets have historically spent more years drifting sideways or chopping around, as opposed to ripping higher. When this occurs and the main stock market indexes are stuck in a sideways range, or trading in a choppy and indecisive fashion, ETFs are better to trade than individual stocks because traders can choose from a diverse selection of commodity, currency, fixed-income, or international ETFs, each of which generally has a low (or even zero) correlation to the direction of the broad stock market. This enables traders to locate a specific type of ETF that may still be trending steadily, even if the main stock market indexes are not. One example of this is how precious metal ETFs (such as gold and silver) have generally ignored the overall stock market in recent years by trending steadily higher, even in periods when the US stock market was range-bound. Because of this ability to trade ETFs with a low correlation to overall stock market trend, I trade more ETFs than individual stocks in choppy, range-bound, or dull stock markets.

How to determine the best ratio of ETF trading vs. stock trading

Since it is more profitable to trade individual stocks in raging bull markets, but better to trade ETFs in other market environments, you should now understand the major advantage of trading a mix of both ETFs and individual stocks. Continually shifting the portfolio weighting between ETFs and stocks gives traders the ability to outperform the main stock market indexes in strong, bullish trends, while still being able to find profitable, low-risk trading opportunities in flat or choppy markets (in overly weak bear markets, sitting on cash or selectively selling short is the safest bet). The end result of this trading style is a less volatile trading portfolio with a smoother equity curve.

When trading both ETFs and individual stocks, it is of utmost importance to know the ideal ratio of ETFs and individual stocks in your portfolio at any given time, based upon the current market environment. To do this, one should first have a reliable system for timing the stock market that indicates the overall health and reliability of the current market trend.

From personal experience, I have found the services of Morpheus Trading Group (http://www.morpheustrading.com) to be quite useful for short to intermediate-term traders who are looking to profit from trading a continually shifting mix of both ETFs and individual stocks. Their main service is called The Wagner Daily, a nightly swing trading newsletter that provides their top stock and ETF trade picks (based on technical trading), and is in sync with their rule-based market timing model.

The cost of The Wagner Daily newsletter is $79 per month, but my subscription has paid for itself many times over. Furthermore, they also offer a 30% discount for annual memberships (which brings the cost down to about $49 per month). Because they have been confidently providing this swing trading service for more than 10 years, Morpheus even offers a 30-day money back guarantee offer for new subscribers.

Regardless of whether or not you subscribe to a swing trading service such as the one mentioned above, I am sure you will find that trading both ETFs and stocks in your portfolio is far superior than limiting yourself to one instrument or the other.

What do you think? Have you already discovered the benefits of trading both ETFs and stocks yourself? I’d love to hear your thoughts by dropping a note below.

Tags: etf trading, stock trading, swing trading, trading strategy

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