An exchange traded fund is exactly what its name implies – it is a fund that is traded on an exchange. Since the funds are traded like stocks, investors should follow some basic guidelines to optimally execute trades.
For instance, ETF investors should use limit orders to have better control over trades as this order would place a specific price at which you want to buy or sell a fund.
“So, instead of just saying ‘market,’ where you could just get whatever the next offer is or whatever that price will get filled at, with a limit order, you’re specifying, I will pay no more than this or I will sell it at no less than this price,” Street One Financial President Scott Freeze said in a Morningstar report.
However, if a trader is only moving a small position in a highly liquid fund, such as the SPDR S&P 500 (NYSEArca: SPY), limit orders are not typically required since the bid/ask spreads are very tight, or only a penny apart.
“Limit orders really don’t come into play until you’re talking about more esoteric, thinly traded ETFs,” Freeze added. “Maybe if it has a wider spread, say $0.05 or more. If it’s something that trades 400 shares a day, 2,000 shares a day, then you might want to start looking at limit orders, just so that you don’t have any adverse price impact.” [Bid/Ask Spreads]