What is an ETF? — Part 9: Protecting Your Trades
April 29th 2012 at 6:00am by Tom Lydon
Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 8: Trading Costs]
When trading in ETFs or any other equity security, it is prudent to use limit orders, which put the control back into the hands of the investor.
Market orders, which buys or sells an investment at the best available price, may not implement trades on prices originally quoted. This is especially pronounced during times of high market volatility, as witnessed in recent years, or in securities with low volume trades.
Instead, ETF investors should utilize limit orders when buying or selling an investment. This way, the investor will never pay more than he or she intended. Limit orders are trades that specifically state how many shares are bought or sold at a specific price or better. For instance, a buy limit order can purchase an ETF at or below a stated price.
However, it should be noted that limit orders typically cost more than market orders, but this is just the added price to pay for peace of mind. Additionally, if the specified price is not met, the order may never be filed.
Furthermore, we maintain a stop-loss order on all our ETF holdings. A stop-loss order helps limit potential losses on any position. For instance, we have an 8% stop loss on ETF trades, so that if a fund drops 8%, the brokerage will know to sell the investment. By holding a stop-loss order, investors will be able to adhere to a strategy to mitigate potential losses down the line, instead of letting emotions dictate when to sell. [An ETF Trend-Following Plan for All Seasons]
For past stories in this series, visit our “What is an ETF?” 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.