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Exchange Traded Funds Can Help Investors Enhance Their Trading

While IBD's focus is on leading stocks, investors should also take a look at exchanged-traded funds, or ETFs.

ETFs can help enhance your investing experience and boost your stock-market profits. Investors can also use ETFs to glean more information about the market.

Due to their low cost and versatility, investor interest in ETFs has grown sharply over the years. In September, assets in ETFs stood at $1.83 trillion, according to the Investment Company Institute (ICI), up 19% from a year ago.

ETFs tend to have lower expenses than mutual funds. Some brokers such as TD Ameritrade (AMTD), Charles Schwab (SCHW) and Fidelity will let you trade certain ETFs commission-free.

Some ETFs track broad market indexes, such as the SPDR S&P 500 (SPY) ETF, which tracks the benchmark S&P 500 index. Others monitor other segments of the market. If small caps are greatly outperforming in the market, investors can participate via the iShares Russell 2000 (IWM) ETF.

Staying on the right side of the market is key to maximizing gains. There are times when investors should be in and times when investors should be on the sidelines.

IBD has had a long history of helping investors determine market direction with the Market Pulse, but we've gone further with the ETF Market Strategy, which can be found on the ETF page or on Leaderboard, a premium product.

Basically, the ETF Market Strategy helps investors decide how much exposure they should have in the market by following a simple scale of market risk based on the current market outlook.

When the market goes into a confirmed uptrend, investors should be 100% invested. But when the market comes under pressure, exposure should be cut to 50%.

In a market correction, the entire ETF should be sold. Once the market goes back into a confirmed uptrend, investors can return to full exposure. Let the daily Market Pulse table (today on B3) be your guide.

Investors can trade this simple system using ETFs such as the PowerShares QQQ Trust (QQQ) and SPDR S&P 500. Both have extremely high liquidity.

The ETF Strategy was back-tested using the PowerShares QQQ Trust, and sharply outperformed both the S&P 500 and the Nasdaq over the study period from October 2005 to September 2014.

There is an optional rule to help protect capital if a fresh uptrend gets into trouble early. If the Nasdaq slides 2.6% from the closing price of the follow-through day that triggers a new confirmed uptrend, investors should move to 100% cash.

At times, certain industry sectors of the market will be in play. Many ETFs focus on specific areas such as biotech, semiconductors or retail. Investors can examine such sector-oriented ETFs to see what areas of the market money is going into.

There are even leveraged ETFs that give investors double or triple the exposure to a sector or broad index. But beware that some of these ETFs are thinly traded, so stick with the more active ones.

Among some sector ETFs, SPDR Financial (XLF) and SPDR Energy (XLE) have plenty of liquidity. They trade tens of millions of shares each day.