Thomsett's  Instablog

Anyone familiar with traditional mutual funds will fund exchange traded funds (ETFs) a refreshing and new approach. The ETF holds a "basket of securities" identified with a specific theme (market sector or regional currency, for example). In comparison, the old-style mutual fund relies on management to pick a portfolio and to decide when to buy and sell positions.

The advantages of ETF are many: the portfolio is known in advance, management fees are lower, and shares trade on the public exchanges just like stocks. (Old-style mutual fund shares have to be traded directly with the fund, and always based on end-of-day net asset value. Another advantage: many ETFs allow options trading, making the product even more interesting.

So what is the disadvantage? In a word, the diversification is an advantage, but also could be a problem. If you want, for example, to invest in the energy sector, an energy ETF gives you broad exposure to many companies. But that's the point. Why buy the average when you can focus on the one or two strongest competitors in the field. If you are willing to do your research, you are more likely to profit by focusing on a few exceptionally strong companies. With an ETF, you are going to earn the average of all the stocks in the basket, including under-performers.

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The potential of the ETF market is strong, but the potential problems create a dilemma, and potentially a serious one. Before buying shares of any ETF, consider the offset between under-diversification and over-diversification.

Some energy ETF's:

Dow Jones-AIG Energy Total Return ETN (JJE)
United States Oil Fund (USO)
Goldman Sachs Crude Oil Total Return ETN (OIL)
PowerShares DB Crude Oil Long ETN (OLO)
PowerShares DB Crude Oil Short ETN (SZO)
PowerShares DB Oil Fund (DBO)
Teucrium WTI Crude Oil Fund (CRUD)
United States 12 Month Oil Fund (USL)
United States Brent Oil Fund (BNO)
United States Heating Oil Fund (UHN)
United States Short Oil Fund (DNO)

Michael C. Thomsett is an instructor with the New York Institute of Finance, where he teaches five courses. He is also an investing and options and technical analysis author. He wrote the best-selling Getting Starting in Options (Wiley, http://tinyurl.com/22nmkf2), now in its 8th edition. Thomsett's latest book is Trading with Candlesticks. (FT Press)