ETF trading best practices
You've found the right exchange traded fund (ETF) and you’re ready to buy it. Use these strategies to improve your ETF trading experience.
David Stephenson
Aug. 17, 2020
4-minute read
Avoid trading around market open and close
The reason for this is simple. All of the ETF’s underlying securities may not have started trading within the first few minutes of the trading session. In this scenario, a market maker cannot accurately price the ETF, leading to potentially wider bid-ask spreads. And near the end of the trading day, market participants seek to limit their risk and may be reluctant to take on large positions. With few market participants willing to make markets, spreads can widen.
You may be accustomed to market orders where your trade is essentially filled immediately at the prevailing market price.
Limit orders give you more price control and protection when placing an order, so as an investor, you actually set the price that you’re looking for. Remember, this means you're trading off fast execution for securing a certain price. In other words, you might set a price that’s too aggressive and your order may not get filled.
Example: You want to purchase ABC Japanese ETF, which is trading at $25. You set a buy limit order at $24.90. If you set the limit too low, you risk missing the trade in the timeline you want.
A common concern we hear from investors about ETFs is that the market price for an ETF might move away from its net asset value (NAV).
The reason that happens is that at some point each day all overseas markets close. For example, European markets typically close around 11:00 am ET, and there is virtually no trading overlap between Canadian and Japanese equity markets. But our markets continue trading here in Canada with new information, and market participants continue trading ETFs that reflect this new information. In effect, when we see the market price differ from that set NAV, market participants ask, “What would be the value of this ETF if those underlying securities markets were still open?”
Example: So what would be a good strategy in this scenario? If trading an ETF with European stocks in the underlying basket, it may be smart to trade when European markets are open (in the morning, if trading from Canada). Any time a market maker can’t buy the underlying stocks in real time, a wider bid-ask spread or greater premiums or discounts to NAV can result.
An ETF’s average daily volume alone doesn't determine its liquidity. This is a common misconception about ETFs. Unlike stocks, where liquidity is based on trading volume, the underlying holdings of an ETF reveal its true liquidity. For example, if a large cap Canadian equity ETF only trades a few hundred shares a day, it can be just as liquid as one that trades millions of shares a day. Investors should pay attention to the bid-ask spread and the liquidity of the underlying securities to understand the overall liquidity. An ETF’s bid-ask spread includes both the liquidity of the underlying securities, as well as the costs associated with the creation and redemption process.
If you want to place large trades of an ETF at a particular time of day, you may not get the best price. Most ETF providers offer additional support for these types of trades, as can your brokerage platform at CIBC Investor's Edge. Consider calling a CIBC Investor’s Edge representative who can connect you with the block desk, which will facilitate the order effectively.
Created by
David Stephenson
Director, ETF Strategy, CIBC Asset Management
