Stock liquidity and exchange traded fund (ETF) liquidity are not one in the same. Although ETFs are made up of stocks, they follow their own liquidity rules. If you own an ETF that has low trading volume, and therefore, low liquidity, there are options when trading. [Understanding ETF Liquidity.]

In a recent article for AdvisorOne, we discussed ETFs and liquidity. One option is using the services of alternate liquidity providers. The providers facilitate the process of trading ETFs by providing a market for even the most thinly-traded fund, and they’re opening up new worlds for advisors and investors, making it possible for them to invest in ETFs that they once feared would be illiquid. Price discovery and execution are the results of using this service.

Here is some information about liquidity, from Paul Weisbruch of Street One Financial:

  • ETF Liquidity Determined: “ETF liquidity has everything to do with ‘what is inside the index, or basket’ that the ETF is based upon and has very little to do with the daily volume in the product.” It is reflected by the liquidity in the shares represented, together.
  • ETF Structure And Liquidity: The basic designs of an ETF allow investors to trade intraday, and if executed properly, they can enter or exit large positions with negligible price impact in terms of the underlying basket. ETFs usually reflect their true underlying value. [The Creation And Redemption Process Explained.]

If you have true liquidity concerns about your ETF never use market orders, regardless of what type of ETF you plan to trade, or whether the ETF is heavily traded or one that trades lightly. This can ultimately hurt a portfolio’s performance due to lost points on trades.

A limit order can be a better alternative. Weisbruch suggests contacting a trading desk for a trader who understands ETFs are not closed end funds, which can be common.

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.