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What are the Best Practices for Trading ETFs?

Exchange traded funds (ETFs) have become one of the most popular types of investments today. ETFs are traded as easily as any other listed stock on an exchange. When it comes to ETFs, seemingly small trading factors can have a big impact on the overall investment. Here are a few tips to help you navigate the ETF space:

1. Use Limit Orders

Use limit orders when buying or selling ETFs. Although risking the chance of not filling your complete order at the moment of order entry, limit orders set the desired price for the order and can avoid many poor execution pitfalls. Especially true for newer funds, low volume periods, or during volatile market environments, using limit orders to execute ETF trades should be considered the preferred method of order entry.

2. Know Your Market

Be mindful of volatile market periods. Wide swings in the underlying securities or markets that transact infrequently may influence the bid/ask spread of an ETF leading to less desirable executions, if an investor is not careful. Many ETFs have intraday net asset value (iNAV), which provides a current estimate of the ETF’s Net Asset Value. The iNAV of an ETF is generally updated several times a minute, but volatile movements may create a temporary disconnect between the price of the ETF in the market and the stated iNAV. The iNAV may remain static if the underlying security is tied to an exchange that is closed or operating in a foreign market (i.e. London Stock Exchange(LSE) vs New York Stock Exchange (NYSE)). Also, markets where securities transact less frequently, like some bonds, may cause iNAVs to reflect stale prices and be less accurate indicators of value.

3. Use Caution Near The Market Open And Close

Be extra cautious during the moments near the open and close of the listing exchange. The bid/ask spread is the difference between the prices quoted for the sale (ask) and purchase of a stock. Market makers may not have a tight bid/ask spread right at the opening of the market and can lead to undesirable executions when entered before or around opening time. Traders may also witness a widening of the spread late in the trading day as fewer market participants are active as the close approaches. Additionally, authorized participants (APs) may need to balance their books towards the closing of a market and may be reluctant to take on large trades towards this time. If trading must be done during these periods, consider using limit orders to reduce the chances of a poor execution of your trade.

4. Go With The Flow

Stocks and funds on exchanges such as the NYSE are traded in an auction market. More active and frequently-traded stocks and funds may have tighter spreads. However, volume is not the only gauge of the liquidity of an ETF. Market participants are constantly reevaluating the relationship between the price of the fund and its underlying securities, and should quickly correct any perceived mispricings. Again, using limit orders can help investors execute at an acceptable price in ETFs with lower volume.

5. Reach Out For Assistance

When trading larger quantities of shares of any ETF or transacting in an ETF where you may be uncertain of how to best execute, consider reaching out to your broker, trading desk, or directly to the ETF provider to help facilitate in the desired execution of your trade. This method of leveraging ETF trading experts can help avoid potentially costly mistakes that may arise from trading on your own.

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