Exchange traded funds (ETFs) were among the most heavily impacted securities during yesterday’s market turmoil. What happened, and what lessons can be learned from the sell-off?
How were ETF investors affected during Thursday’s volatile market swing? It’s important to understand that outside the 20-minute free-fall, it appeared that the markets acted efficiently. However, during that 20-minute decline, something obviously went awry and the exchange are still researching and reporting on why some stocks and ETFs had pricing and trading at a fraction of their actual cost.
The exchanges have agreed to cancel some of the trades that took place in the 20-minute period, but only for securities that were at least 60% away from their original prices, says Reuters. This means some investors will be affected by the volatility.
While it’s too soon to tell if ETFs were a contributor or a victim in yesterday’s market nosedive, reports suggest that there was some kind of role.
Three-quarters of the canceled trades were ETFs and during the volatile 20-minute period, one-third of the trading volume was ETFs; a heavier than normal portion of that was in leveraged and inverse ETFs. The New York Stock Exchange said that 173 securities – 111 of which were ETFs – were affected by the sell-off. The Nasdaq said 281 securities – 193 of which were ETFs – were impacted on its exchange.
Yesterday, about 210 of 980 ETFs were sold at some point at more than 50% below their eventual closing price, according to Morningstar’s research.
The impacted funds were among the largest and most popular in the industry, including the iShares Russell 1000 Value (NYSEArca: IWD), whose price dropped from $60 to 8 cents before jumping back a few minutes later.
What gives? No one knows for sure, but what many people do know is how popular ETFs are with active traders – particularly leveraged ETFs. Many ETFs also represent the prices of hundreds of single stocks.
ETF providers are all aware of the issue and they’re calling for the exchanges to provide a more reliable marketplace for investors.
This CNBC video explains some of what happened, as well:
Important Lessons Learned
1. Those investors who placed “Good ‘Til Canceled” orders – or GTC orders – had those sell orders triggered at the market price, resulting in sells way below the actual market price. GTC orders are orders to buy or sell when the security reaches a set price. It’s in place until the investor cancels it or the trade is executed.
For example, if a stock is trading at $50 and you have a GTC order to sell at $40 and the stock drops to $38, the stock is then sold at the current price of $38 – not $40.
2. Many of the sells may have been from panic sellers who placed market orders as everyone was heading for the exits, rather than placing limit orders and controlling the price they paid. Market orders are orders to buy or sell at the current price, no matter what the price may be.
Having a limit order in place puts the control back into your hands by letting you set the price at which you’re willing to buy or sell. [How a Market’s Decline Affects ETF Trading.]
Up and down markets don’t make anyone feel good. It’s in these kinds of markets where a strategy becomes more crucial than ever. What we saw yesterday was likely fueled by a lot of emotional panic selling, and if you panicked, you got hurt. A trend following strategy can help you put your emotions aside and so you can execute trades with logic. [Why Have a Stop Loss?]
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