1. Avoid trading within the first and last 15 minutes of the trading day
Avoid Market Open
Not all of an ETF’s underlying securities may have started trading within the first few minutes of the trading session. In such a case, the market maker cannot accurately price the ETF, potentially leading to wider spreads.
Avoid Market Close
As the market close for the ETF’s underlying securities nears, market participants seek to limit their risk. With fewer market participants willing to make markets, spreads can widen.
2. Use limit orders to seek a balance between timely execution and price
Buy and sell ETFs using limit orders:
You want to buy X shares of an ETF, but don’t want to pay any more than Y dollars per share.
Use a limit order to specify a price equal to or greater than the ask price (but not more than what you want to pay). This order increases the likelihood that your trade will be made and avoids the risk of paying more than desired.
You want to sell X shares of an ETF, but don’t want to receive less than Y dollars per share.
Use a limit order to specify a price equal to or less than the bid price (but not less than what you want to receive). This order increases the likelihood that your trade will be made and avoids the risk of receiving less than desired.
Key Differences Between Market and Limit Orders:
Buy or sell right away at the best available current price. Priority is fast execution, not securing a certain price.
No upper/lower limit on the price the trade could be made at, meaning you could pay more than you wanted.
Use to set a target execution price. Priority is securing a certain price, not fast execution.
Your trade may not be executable at the specified price, or only partially executed, requiring an additional trade at a modified price to completely fill the order.
3. Keep an eye on market volatility
In times of market volatility there is a widening in ETF bid/ask spreads – the difference between what ETF sellers are prepared to accept and what ETF buyers are willing to pay. Premiums or discounts of the ETF’s market price relative to the net asset value (value of the underlying securities) may also occur. In these environments, seeking trading assistance and using limit orders may be advisable.
4. Focus on historical spreads and not only recent trading volume
A common misconception is that an ETF’s average daily trading volume alone determines its liquidity. In reality, the best measure of an ETF’s liquidity is determined by the liquidity of its underlying securities. An ETF’s bid-ask spread is a preferred measure of liquidity because it includes the liquidity of its underlying securities and the costs associated with the creation/redemption process.
5. Look at bid/ask prices to gauge the current market price
Current bid and ask prices are a better measure of the fair value of an ETF as they are representative of the basket of securities in the ETF itself. You should note, however, that the market maker bid-ask may not be the highest bid or lowest ask (also known as “top of book” bid-ask). Rather, the market maker bid-ask spread serves as a range to manage the price of the ETF. Using the last traded price can be problematic as the market environment may have changed and the data may be stale.
6. Time can be a factor for international ETFs
ETFs which trade in Canada and the U.S. can be constructed in whole or part from international securities. International markets in which these securities trade, may be closed when North America is open for trading. When those markets are closed information continues to flow that may affect the security prices which contribute to the ETF price. It is the responsibility of the market makers to make adjustments to the ETF price during North American trading hours to reflect the new information. The market maker’s ability to make these adjustments is aided by proxy securities, but is most accurate if or when the international market is open and trading and overlaps with North American market hours. Therefore, it may be preferable to trade the ETF during the trading hours of the underlying securities if possible.