Liquidity is a word that pops up often in the markets, but what it means for exchange traded funds (ETFs) isn’t necessarily what it means for other types of securities and asset classes.
A common assumption is that an ETF’s liquidity is determined by its trading volume, but that isn’t necessarily so. The trading volume is more of an indicator of a funds popularity and how much it traded in the past – not how liquid it is. [The Creation/Redemption Process Explained.]
Sara Grillo for the Business Insider says the better gauge of liquidity is to look at the hypothetical number of shares that can be traded. This depends on the liquidity of the underlying holdings in the basket. [It’s Official: Fee-Based Advisors Prefer ETFs.]
If a stock is thinly traded, and it is inside of the funds basket, this can pose more of a problem, no matter how often the ETF itself is traded. Likewise, some ETFs that appear tough to trade can be highly liquid as a result of their underlying holdings. [6 Things Every ETF Investor Should Know.]
If you’ve got concerns about liquidity and want to place a large order on an ETF, consider contacting an alternate liquidity provider, who will help you with trade execution and get you the best price.
Tisha Guerrero 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.