On the face of it, buying and selling exchange traded funds (ETFs) is very simple. But behind the scenes is a cast of characters who make it all happen; knowing who’s who may not only help you trade better, but you just might impress your friends at parties.
Behind the scenes of any ETF is a group of people involved in making these funds the best they can be for investors, buying and selling them all day and essentially making the process as smooth as it can possibly be. [Switching from Mutual Funds to ETFs.]
- Market Makers: Market makers help the markets and exchanges run smoothly. Their role is to maintain liquidity by offering to buy or sell ETF units when nobody else will, and also to set the standards for the bid and ask prices. Market makers are similar to a shopkeeper who operates on both the buy and sell side. They also provide a backup layer of liquidity to the markets in case an ETF gets out of whack.
- How units are created: Market makers also make up units for you to buy. If there aren’t enough units to fill the order, no problem! More are made. Once your order comes in, the maker purchases the underlying stocks in the ETF and delivers the shares to the ETF provider, who issues the market maker the new units. [How ETFs Are Created and Redeemed.]
- Market orders: Limit orders – which specify a price – are preferable because they put the pricing in the investor’s control. A limit order puts a cap on how much you’ll pay and only orders that come in below that price will be filled. [How to Trade Large Blocks of ETFs Efficiently.]
- Trading times: Avoid trading shares and ETFs for the first 10 minutes after the opening bell, and before the last 10 minutes of the trading day. There is less liquidity in the underlying stocks at these times, which makes it more difficult for market makers to hedge themselves, and the prices become more volatile. [10 Tips for Trading ETFs.]
For more stories about ETFs, visit our ETF 101 category.
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.