Investors should not judge an exchange traded fund’s overall liquidity based on per-conceived notions of liquidity taken from the broader equities markets.
When evaluating the liquidity for an ETF, investors should consider the perceived liquidity and the so-called hidden liquidity, instead of using traditional notions of liquidity taken from trading company stocks, according to alletf.
Traditionally, it is common practice to utilize a combination of the average daily volume and the bid-ask spread to determine liquidity for a stock. However, a number of thinly traded ETFs are based on very liquid markets. Consequently, traders can execute large trades without distorting the ETF price. [ETF Liquidity, Trading and Market Making]
Moreover, volume does not reflect movements in a fund’s underlying market. For example, fixed-income ETFs may trade on days the bond markets are closed. International stock ETFs may trade on the U.S. stock exchange when the overseas markets are closed.
Many ETF investors may find that ETFs are truly only as liquid as their underlying holdings. ETFs that track U.S. stock are among the most liquid, whereas ETFs that track emerging markets where capital markets are not as developed will also be less liquid.