Exchange Traded Funds | Jun 28, 2010 | 0 Comments

How to Buy Exchange Traded Funds

Take Advantage of ETFs . . .

For the past few years I’ve been talking to friends, family and readers about exchange traded funds. But, Financial Rebel really hasn’t taken this to the next level (something I’m working on changing now). Even though ETFs have been around for some time, they are really starting to heat up. If you’re ready to get in the game, here’s a quick step-by-step list on how to buy your first exchange traded fund.

I am assuming you have a stock brokerage account somewhere. If not, you’ll need to get one before buying your exchange traded funds. At the end of this article, I’ll recap the exact settings used for this demonstration. And if you’re brand new to ETFs, you may want to read my quick overview about them here.

Step One—Pick Your Exchange Traded Fund

The first thing you need to do is pick an ETF to buy. In case you don’t know already, exchange traded funds work much like individual stocks. You can buy and sell them as you’d like and in the quantity you desire.

Unlike a mutual fund, which may have a higher point of entry, you can buy a single share of an ETF if you want. For our example, I’ll use a good gold investing exchange traded fund. The symbol is GLD.

Step Two—Select Number of Shares to Buy

Now that you know what you’re going to buy, the next question to answer is one of quantity.

As I just mentioned, you can buy as little as one share of the ETF you’re interested in, although I don’t recommend just buying one share.

Always keep your stock broker’s fees in mind. Your stock broker should charge you the same commission as a stock trade. For example, at Scottrade, it would be $7 per transaction. However, some stock brokers are starting to reduce fees for ETF trades and they may even be commission-free.

Using the $7 example, if you bought just a single share of an ETF that was say $100, you’d need a 14% increase just to cover your total commissions for the trades involved (buying and selling). If you wait to buy say 3 shares, your required increase drops down to around 4%—a big difference for just a couple of shares.

I’d like 100 shares of GLD, so just a minimal gain of 14 cents per share covers all of my transaction costs.

Step Three—What Price?

In our example, I’m going to buy the exchange traded fund GLD and I want 100 shares. From here, I have two options in regards to price.

Option One: I can put in a “market order” for my shares. This means I will get my 100 shares at whatever price the market decides. It could be a little higher or lower than you see quoted at your broker or other financial site. As a rule, I never use market orders unless absolutely necessary.

Option Two: I can put in a “limit order” for my shares. This is the way to go. Rather than just accepting any price blindly, I’m going to specify my exact price per share I’m willing to pay. If my order can’t be met, I won’t get my shares. However, if the price is met, I’ll get my shares at the price (or better) that I specified. No surprises.

Looking at the latest quote, I see GLD is trading at $121.09. I’d like 100 shares at $120 or better.

Step Four—Selecting Your Order Duration

When you enter your new ETF order, you have two options. You can either select good for a day  or good until canceled.

This is just a personal preference and these orders act just like their name implies. If you select good for a day, your order will be canceled at the end of the day if it is not executed.

If you select good until canceled, it will remain in the order system until it’s executed or canceled manually by you.

For our example, I’ll select good for a day because if I don’t get in GLD today, I will reevaluate the market tomorrow.

Step Five—How to Minimize Potential Losses

So your oder was just executed and you’re the proud owner of shares in your favorite exchange traded fund. Now what?

Here’s the key. You need to place a stop-loss order. When you do this, you won’t have to worry about your ETF going to $0 should it start going the wrong way. Again, you’re presented with two options.

Option One: Use a general stop-loss order. This is a market order to dump your stock once it hits a certain point. I don’t like using these, because there are too many variables. However, this is just a personal preference.

Option Two: Use a stop-limit order. As our limit order above, this type of stop-loss order means the system will dump your shares if a certain trigger is hit.

An example would be selling our 100 shares of GLD if the price hits $115.

Putting It All Together

1. We selected our ETF to buy (GLD).

2. We selected the number of shares to buy (100).

3. We selected how to buy them (limit order—we set our own acceptable price).

4. We selected how long the order should remain pending (good for a day).

5. When we got out shares, we told the system how much loss we were willing to take (stop-limit order).

I hope you found this article beneficial. If you have questions about buying exchange traded funds, please ask. Don’t forget to look around Financial Rebel’s ETF section for more information.