What You Should Know About ETF Bid/Ask Spreads
February 6th 2012 at 6:00am by Tom Lydon
Like stocks, exchange traded fund prices can change through the day, and investors seeking to take on positions will have to be mindful of the bid/ask spreads when determining the best point to enter or exit a trade.
The bid/asks spread is the difference between the bid or ask price of a particular stock. More often than not, the asking price of an investment exceeds the bidding price – the number of sellers tend to exceed the number of buyers.
Since the bid/ask spread is based on the market supply and demand, highly liquid ETFs usually have tight bid/ask spreads that are just pennies apart, whereas thinly traded ETFs may show wider disparities. [How Lower Trading Volume Impacts ETF Investors]
Remember, an ETF’s liquidity is not determined by trading volume alone. It also depends on the liquidity of the securities in which it invests. For example, S&P 500 companies are more liquid than emerging market bonds.
Potential ETF investors should keep an eye on the spread as wider bid/ask spreads may eat away at potential returns on an investment. Spreads are more an issue for traders than for buy-and-hold investors. [How to Use ETFs in a Trend-Following Strategy]
While there are many different types of trading options, we suggest sticking to limit orders. Limit orders help ensure optimal executions on trade orders and help individuals take more control when trading. [What Investors Should Know About ETFs and Stop-Loss Orders]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.