An Exchange Traded Fund (ETF) is a hybrid between a stock and an index and is a vehicle for investing directly in a specific market. ETFs are traded on the stock exchanges as regular stock but reflect the performance of a specific index. Like stocks, shares are bought and sold through a broker, dividends are paid to stockholders, and shares can be bought on margin. The difference is that ETFs are a fixed portfolio of securities that mirror a particular index. Think of an exchange traded fund as a mutual fund that trades like a stock.

ETFs may be the better investment if the market is doing well and one of your specific stocks is not. For example, when you buy DIA, you are buying a piece of the portfolio of stocks that compromise the Dow Jones Industrial Average (DJIA). Buying separate shares of the 30 stocks that comprise the DJIA in order to have a portfolio that mirrors the index would not be practical.

The first exchange-traded fund was the S&P 500 index fund (nicknamed spider because of the SPDR ticker symbol), which began trading on the American Stock Exchange (AMEX) in 1993. Today there are hundreds of ETFs trading on the open market.

Here are some important points to know when investing in ETFs:

1) You can easily buy them through your broker and buy as little as one share.

2) You can short them and purchase on margin.

3) Expense ratios for most ETFs are lower than those of the average mutual fund.

4) You pay your broker the same commission that you'd pay on any regular trade.

5) Be prepared for tax implications as there is less incidence of capital gains consequences. Also, dividends may be issued.

6) Valuation is not precise the ETF may not mirror the index 100%. It is not uncommon to see a 1% or more difference between the ETF and the index's year-end return.

7) ETFs provide instant diversification.

Popular ETFs include:

1) QQQ: Mirrors the Nasdaq 100.

2) SPDRs: Standard & Poors Depository Receipts. The main SPDR tracks the S&P 500.

3) HOLDRS: Merrill Lynch issues specific sector ETFs that are traded on the AMEX.

4) iShares: Barclay's brand of ETFs that trade on the AMEX. Barclay has put out a number of technology-oriented iShares that follow Goldman Sachs's technology indexes.

5) Vipers: Vanguards brands of ETFs cover many different areas of the market including the financial, healthcare and utilities sectors.

6) DIAMONDs: Diamonds Trust Series that tracks the Dow Jones Industrial Average. The fund is structured as a unit investment trust. The ticker symbol of the Dow Diamonds is DIA, and it trades on the AMEX.