Best practices for trading ETFs

By following a few best practices, you can help achieve favourable prices for your ETF trades.

 

Use limit orders

Limit orders let you determine the maximum or minimum price at which you are prepared to buy or sell an ETF. While limit orders offer you control over execution price, there is always some risk that your order won't be fully executed. Where execution is a priority, consider using a marketable limit order.

Market orders can be effective when you're buying or selling ETFs with significant liquidity and narrow spreads. However, since the overriding objective of a market order is trade execution rather than price protection, it is still possible you will receive an undesirable price for your trade.

 

Consider market volatility

Be cautious during periods of market volatility or when there are major events occurring that could affect markets. Market volatility can cause the prices of an ETF's underlying securities to move sharply, which can in turn cause an ETF to trade with a wider bid-ask spread and/or at a larger than average premium or discount. Limit orders may be beneficial in such situations because of the price protection they provide.

 

Keep abreast of the news

Investors should pay attention to market news as ETF prices may move in response to the release of economic indicators or statements from central banks (e.g. Bank of Canada rate announcements), as well as earnings and other news from companies that are large constituents of an ETF.

 

Understand liquidity

A common misconception is that ETFs with lower average daily volume (ADV) are not as liquid as others in the marketplace. ADV is generally a good gauge of liquidity for a single stock because the number of its outstanding units is typically fixed. ETF units can be created or redeemed through an authorized dealer, so the liquidity of the ETF's underlying securities is what matters most in determining an ETF's liquidity. When the underlying securities are difficult to trade, it can result in a wider bid-ask spread for the ETF.

Learn more about ETFs and liquidity.

 

Heed the clock and the calendar

Bid-ask spreads can widen at certain times each day or on certain days of the year.

At market open, price discovery is taking place as some of an ETF's underlying securities are beginning to trade. This makes it more challenging for a market maker to price the ETF with certainty, resulting in wider spreads. Where possible, avoid trading near the open and allow time for price discovery to occur.

At market close, fewer firms may make markets in an ETF as market participants try to limit their risk. The result is that there may be less liquidity close to market close than at other times of the day.

When underlying markets are closed, spreads can widen for Canada-listed ETFs that invest primarily in securities that trade on exchanges with different opening hours, for example, a European equity ETF that trades on Toronto Stock Exchange. When the underlying market for securities is closed, it is more difficult for a market maker to price the ETF with certainty, resulting in wider bid- spreads, Other scenarios in which this may apply include fixed income ETFs (bond market closures), as well as Canadian products that wrap a U.S.-listed ETF.

 

Confirm the information

Always ask the trader with whom you are speaking to confirm the bid-ask. This ensures the quote is accurate and that there is no anomalous activity that may not be readily visible.

 

Use an ETF trading desk

An ETF trading desk, if one is available to you, can use various trading tools to help you source liquidity for a large order. Additionally, Vanguard (and many other issuers) maintain dedicated ETF capital markets teams whose mandate is to support investors trading ETFs; the team can be engaged via your Vanguard sales representative.