LEVEL: BEGINNER
You have an idea or investment thesis and want to capitalize on it for your financial gain; this is the universal point of trading. The idea may be about corporate earnings, interest rate policy, supply and demand of oil or a host of other things. The question is, how do you express this in the market? The Zolio platform allows you to trade stocks and ETFs. This means that, unlike portfolio managers of hedge funds that have the ability to use bonds, complex financial instruments, and leverage to express their views, you have to be creative in finding a way to express your specific views through the confines of the stock market. This is very possible and I’ll explain how.
Bullish
You have a positive view on the market and want to express this through a trade or series of trades. You may believe the financial performance of companies are improving and expect earnings to reflect that, the economy is steadily improving and expanding (a rising GDP), and the overall stock market is heading higher (technical analysis would indicate higher highs and higher lows). What do you do? Well, the most obvious answer is: bullish investors buy because they expect assets to increase in value. You can buy specific stocks or you can buy an index fund, such as SPY, that tracks the performance of the S&P 500.
Buying individual stocks concentrates your idea on a specific company and thus comes with a high degree of risk, but if you feel strongly about your investment thesis then it’s an option that should offer a higher yield. Buying an index fund comes with a lower degree of risk in comparison to buying a specific company and allows you to participate in the “rising tide” of the market. However, it may cause you to miss out on the higher gains of a few outstanding companies since you did not invest in those on their own.
Say you’re bullish on a particular industry (homebuilders), market segment (small cap stocks), or region (Sub-Saharan Africa). In this case, ETFs provide a way for you to express those views. There are ETFs specifically for each of the aforementioned categories and many more. Utilizing these options can allow you to broadly express your bullish views without having to make targeted investments on individual companies.
Bearish
Let’s look at the other side of the equation. What do you do when you have less-than-favorable views on the market? Perhaps you believe there will be an economic contraction in a particular country or region, declining corporate earnings, change in interest rates, or hyper-regulation of a particular industry? Contrastingly to the actions of a bullish investor, the simplest action of a bearish investor is to sell, because it is believed that assets will decline in value.
Short sales allow investors and traders the opportunity to profit from bearish views on the market by “shorting” particular securities and profiting from their decline. Shorting involves the sales of stocks that are borrowed. In other words, you do not own the stocks. You sell this “borrowed” stock in the market, and if the price of the stock declines you buy the stock back at a lower price than where you sold it, thus closing out the trade and capturing a profit. Short sales require margin to be posted and does come with a degree of risk. For instance, say your thesis is wrong and the market has an upswing. This shift in momentum could cost you a lot of money very quickly.
Say you’re bearish on the overall market, a particular industry (financials), or region (Europe). The purchase of an inverse ETF can allow you to express these views. Investing in an inverse ETF is similar to holding various short positions without the extra risk of shorting a stock, thus making them a very attractive choice for bearish investors. Inverse ETF’s utilize derivatives and move in the opposite direction of the market, meaning they gain in price as the underlying securities or index that the ETF tracks, declines.
To choose an inverse ETF, investors need to be careful and know as much as they can about ETFs and leverage before making the trade. This is because some inverse ETFs are more inefficient than actually shorting the stock, either due to low liquidity or inefficient management. Due diligence is more important when investing in an inverse ETF, and traders should understand the market and the mechanism fully before going down this road.
Other
The Zolio platform doesn’t allow you to trade fixed income, currencies, and other asset classes but you may want exposure to those asset classes. What do you do? Again, ETFs and Closed-End Funds (CEFs) are a great resource. There are thousands of these funds available each with a specific focus, including fixed income, currencies, and non-equity asset classes. The ETFs generally track an index and mimic the performance of the underlying asset class. Be aware that the ETF will not fully track the performance of the asset class itself it tracks, but it does provide you some exposure to these various market segments. Note: Although the ETF’s track non-equity indices they are subject to the vicissitudes of the stock market and will behave accordingly.
Conclusion
Expressing your views on the market requires careful analysis and execution of those views. There are many ways to express the same view in the market, the most important takeaway is to find a method that is in line with your trading style, strategy, and supports your overall thesis. Also be mindful of a correlation in regards to your different positions. A well balanced, diversified portfolio is the best way to achieve maximum returns while minimizing risk. Having a concentrated portfolio is very risky and could lead to dismal returns if those view investments all move in the same direction based on market dynamics.