Let’s Talk About ETFs

Using x-ray vision through markets

Today we’re gonna talk about ETFs. ETFs are a massive needle mover for me and have been Since 2008. For 12 plus years now, they’ve been growing influential force over the markets, and this influence is not going anywhere. The sooner you can understand the influence; why it’s happening, harness that, and use it, you’re gonna have a tremendous advantage over other traders and investors. 

So let’s talk about ETFs, not from the standpoint of what they are… 

Let’s just presume this very basic understanding of what an ETF is….

 It’s usually a collection of stocks.

Sometimes an ETF can represent commodities, as in the example of TLT, which is a bond ETF or USO, which is the crude oil ETF. But if we’re gonna talk about, for example, the NASDAQ, you can look at NASDAQ futures, or we can look at the QQQ, which is a collection of stocks. 

We can take a look at the XLK, which is an individual sector representing tech, and again, it’s a collection of stocks. 

So what are the pros of ETFs? 

Well, from a trainer’s perspective, the pros of ETFs are that they’re liquid. They also have typically active options chains, and the options are liquid and low cost. 

So if you are gonna basically bring down a two really plus points for an ETF, they’re liquid and they’re low cost, especially at the options chain if you wanna buy calls and puts, because we’re trading and that’s gonna give you the leverage. 

What are the cons to it?

Well, the cons of ETFs are, there are so many of them and yet probably truly less than 3% of the growing number, and they’re in the thousands, are actually influential and have a lot of liquidity. 

So that con means that downside we need to be aware of which ETF to watch and why we’re watching them. So let’s talk about the upside and downside of high concentration weighting, because when we talk about ETFs being made up of stocks let’s talk about the XLK.  

The XLK is primarily Apple and Microsoft. 

High concentration weighting means the number of stocks in any ETF are usually going to be a small number of stocks that have disproportionate weighting.

That is the downside. So in this example of XLK, Apple is just about 22% of the ETF, and Microsoft is right around 21%. So you’re talking about over 40% of the weighting in this ETF and two stocks. Now, just to cut to the chase. What does that even mean? High concentration weighting. 

What does that mean to us? Tactically.

That means a very small number of stocks can move a sector. By the way, the same thing applies to the QQQ, SPY, and DIA ETFs of indices. But what’s the upside to this? 

This is not all bad news. If you know that the XLK is mostly Apple and Microsoft, if you see a movement in these two stocks, you’re pretty much going to get a very clear idea of XLK. XLK Visa Versa, gonna give you a very clear idea of names like Apple, Microsoft, Visa, and PayPal. 

So the upside of high concentration weighting is with a handful of ETFs and a handful of stocks, you have a very clear idea of what’s happening in the equity markets. Why are then ETFs and missing link to your trading? Think about what ETFs now have influence over the markets based on the liquidity and their attention and their activity and the sheer volume. 

The ETFs reflect what’s happening in some of the most popularly watched and traded stocks out there. 

This in turn tells you where the market has its focus, and if that focus is bullish, bearish or indifferent. When you’re able to get that kind of information, you add in the high concentration weighting, your understanding of trends, when trends are likely to roll over the weighting stocks have, and the important stocks have in those trends… 

Now you’re seeing the market in a way that is reflecting the flow. It’s reflecting what’s happening more broadly. So when you put those pieces together, ETFs are absolutely gonna give you a certain amount of x-ray vision through the market.


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