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An ETF is essentially a trust that owns a portfolio of assets tied to a market index, a sector index, a commodity, maybe even a basket of fixed instruments. When you buy an ETF, you’re just buying shares in that trust. Generally, the goal of the ETF is to match the performance of the index or commodity it’s tied to. Not to do better. Not to do worse.

Advantages over traditional mutual funds

lower expense ratios. As of February of this year, Morningstar reported that the average gross expense ratio of over 20,000 traditional mutual funds was 1.67%. In contrast, for the 200-plus ETFs it was only 0.44%. In that sense, for every dollar it costs to run the average mutual fund, it costs only about 26 cents to run the equivalent ETF
Many — but not all — traditional mutual funds charge sales commissions or “loads.” That’s why Money and Markets has always recommended strictly funds that do not charge the loads. No sales loads on ETFs. Of course, you still have to pay a broker commission, just like a stock. But your commissions can be at discount rates, or even at the deep-discount rates available with many online brokers.
Plus there’s one more cost advantage: ETFs have been much more tax efficient. Morningstar actually has a measurement for this — its “tax-cost ratio” — and it’s typically better for ETFs than for traditional mutual funds.
Since ETFs are listed on exchanges, just like a common stock, you don’t run into a lot of the trading restrictions that traditional mutual funds often impose:
You can trade as often as you want — no minimum holding periods, no penalties for switching frequently, etc.
You can buy and sell any time during the trading day — not just at the settlement price at the end of the day like with most mutual funds.
You can use stop-loss orders to help protect your capital.
You can use limit orders, setting a target entry or exit price.
And you can choose from a huge diversity of ETFs. There are over THREE hundred ETFs now. A large portion of them are sector and industry ETFs.
There are also ETFs designed to track fixed-income markets such as the iShares Lehman 20-year Treasury Plus Bond (TLT) and iShares Lehman Aggregate Bond Index (AGG). There are ETFs that track commodities, like iShares Silver Trust (SLV), which tracks the price of silver bullion, allowing investors to invest directly in silver in the form of a security.There are ETFs tied to foreign countries and regions.
whatever you can do with stock — buying on margin, selling short, etc. — you can generally do with ETFs as well
If you have a large portfolio of a particular category of stocks, and you’re worried about a decline, selling short ETFs that approximately match your portfolio can be a good protective hedge
20 Most Popular ETFs

Nasdaq 100 Trust            QQQQ

SPDR Trust (S&P500)        SPY

iShares Japan                    EWJ

iShares Russell 2000          IWM

Semiconductors Holdrs       SMH

SPDR Energy Sector           XLE

Oil Service HOLDRs            OIH

SPDR Financial Sector        XLF

iShares S&P SmallCap        IJR

Diamond Trust (Dow)         DIA

SPDR Utility Sector            XLU

iShares MSCI EAFE            EFA

StreetTRACKS Gold            GLD

IShares Emerging Markets EEM

Retail HOLDRs                    RTH

iShares Brazil                    EWZ

iShares Taiwan                  EWT

IShares Nasdaq Biotech     IBB

MidCap SPDRs                    MDY

iShares DJ Real Estate        IYR

DBV: Enhanced currency index, tracks 10 currencies buying the top three highest yielding currencies and shorting the bottom 3.