It would be hard not to notice the recent surge in market volatility. As a firm believer in the low-cost, transparent nature of exchange-traded funds (ETFs), I wanted to provide some tips to my clients and readers about how to handle trading ETFs in this environment. I should note that large, popular ETF issues, particularly equity ETFs, can often be traded like blue-chip stocks without too much worry about volume, pricing, and liquidity. However, when it comes to new issues, obscure issues, or any ETF with low daily trading volume, it can save you money to do a little research and avoid throwing in blind market orders.
My first piece of advice is fairly obvious: use limit orders when possible. Limit orders refer to a specific price at which to buy or sell a security. Entering a limit order will ensure that a person will never pay more for a stock than the ‘limit price’ set. Many of us have had the experience of checking a stock’s price and entering in a market order, only to notice we got executed a nickel or so higher than we expected just a few seconds later. With ETFs, you want to be particularly careful right at the market open. Because ETF pricing is determined by the prices of underlying securities, it’s important to make sure the market for each underlying security is open to avoid wider spreads in pricing. This could happen in a situation in which one of the stocks is halted or perhaps a stock in the underlying index has low trading volume and doesn’t always have orders right at the open.
Along those lines, it should be clear that when trading international ETFs, many of those securities may not be trading at all during the US trading day (i.e. Asia). In those cases, we rely on market makers to keep the spreads as tight as possible but that is obviously harder to do when those markets are closed. If you’re trading a Europe ETF, consider placing your orders before 1 PM when the European markets close and the pricing may become a bit tougher.
The same rules about bid-ask spreads apply to the very end of the trading day, around 3:50-4:00 EST. The bottom line is that you want to be most careful when it comes to ETFs that dabble in thinly traded securities and obscure issues which are harder to price. You’ll always be “safest” in terms of getting tight pricing on your ETF when it comes to popular ETFs, generally on the equity side, with heavy trading volume.
Not only might you be safer from a price perspective using the most popular ETF issues, but you may also notice your annual expense ratio is lower as well. The obscure, thinly-traded ETFs tend to have higher costs because they require more work from specialists. Those costs, naturally, get passed along to those purchasing the ETF.
I am aware that a growing industry of “alternate liquidity providers” does exist to deal with the issues of low trading volume, less-than-desirable levels of assets under management and wide bid-ask spreads.* However, this applies more to institutional traders and firms typically dealing in larger volume than the average retail investor.
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
*Equity-based ETFs are subject to risks similar to those of stocks; fixed income ETFs are subject to risks similar to those of bonds. Investment returns will fluctuate and are subject to market volatility. Shares may be worth more or less than their original cost when sold.
Although exchange-traded funds are designed to provide investment results that generally correspond to the price and yield performance of their respective underlying indexes, the trusts may not be able to exactly replicate the performance of the indexes because of trust expenses and other factors.
Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.
The bid-ask spread is the difference between the current bid and the current ask or offered price of a given security.
Portfolios that invest internationally may be subject to special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other monetary and political risks associated with future political and economic developments.