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1.6 Exchange Traded Funds
What is it?
Exchange traded funds are basically securities that are created to behave the same way as a specific index like Dow Jones, FTSE or a collection of securities. These could be various securities, stocks, indexes or foreign exchange. They are different types of them that are all bundled up and represented as an ETF, which is the price that you see on the chart moving.
The ETF has got a linear relationship with its underlying portfolio. It moves almost in a linear way in relation to the stocks and/or securities that it is meant to follow or it is linked under. One important concept, in terms of the ETF is that, if the ETF is traded lower than the price of the securities that it is bundled under, an easy trade that you can make money out of it is to buy at the ETF price and sell it at the underlying portfolio locking in the profits from the differential.
Market size and Liquidity.
The exchange traded fund is related to the underlying security that it is linked to. For example, the spider ETF. It is linked to the S&P 500 Index. It is the top 500 Technology companies in the US.
The important thing about ETF’s market size and liquidity is that an ETF should not be determined by the trading volume. A small ETF with a small volume can be highly liquid (It's underlying security is highly liquid). For example, the spider 500 ETF might be of low volume of its securities and shares. However, these S&P 500 is highly liquid and is highly traded, which follows the underlying securities’ liquidity.
As I have mentioned in my previous video, the smallest price increment that can happen in any market of the normal transaction world is 0.01. In the UK, its a penny. It is another terminology in other countries. For the ETF, it is known as cents as it is mainly linked to the dollar.
In this module of ETF Market, we looked at what it is, the market size and liquidity, and the price increments.