Given the significant pre-market volatility, there was considerable uncertainty as markets were set to open on Monday, August 24. The subsequent trading events experienced that morning were a result of the price discovery mechanism being delayed across all financial products, including ETFs.
In the wake of these historic swings, with the Dow plunging over 1,000 points on Monday and rebounding over 600 points on Wednesday, August 26, we saw unusual price volatility in some ETFs.1 This market dynamic made it increasingly difficult for market participants to efficiently quote equity and ETF prices, resulting in wider than normal bid/ask spreads and less market depth, which made it more challenging for market makers to provide liquidity. Typically, these are temporary events and how much the spread widens tends to correlate to the perceived risk or volatility of the ETF’s underlying securities.
As current volatility may persist for some time, it’s worth reviewing our thoughts on the best trading practices to guide investors in today’s market. Our first strategy is simple. If you do not have to trade in volatile times, we recommend that you do not. If you choose to buy or sell ETFs, or any other securities, during periods of heightened volatility such as we have experienced this week, we recommend that you place your trades using limit orders.
A limit order identifies the maximum and minimum prices at which you want to buy or sell a security. Unlike market orders that execute immediately at the next price, limit orders do not guarantee execution. They do, however, provide control over price level and allow investors to manage execution risk, which is particularly useful when volatility spikes.
Limit orders generally aren’t necessary, although are still encouraged, for very liquid ETFs, like the SPDR® S&P 500® ETF [SPY], where there are millions of shares offered at each price point with very narrow bid/ask spreads.2 However, limit orders can be a useful execution tool in less actively traded securities and, again, can help to reduce adverse price impact in times of market stress.
We appreciate that the heightened volatility witnessed across markets earlier this week was not optimal. And, while it was not limited to ETFs, we believe there is room for improvement. As one of the industry’s largest ETF providers, we are committed to collaborating with the industry, including exchanges, issuers and other market participants to deliver a higher level of service to ETF investors in all market environments. Our progress on this front is certainly something that we’ll update you on in future blog posts.
SSGA has a long-standing commitment to market quality in our ETFs and deep relationships within the trading community. Our SPDR Capital Markets team is in regular communication with market makers, exchanges and liquidity providers in an effort to monitor the liquidity of our products for the benefit of our clients and investors. Should you have any questions on these events, or ETF trading in general, please call us at 866.787.2257.
1Bloomberg, SSGA, as of 8/27/2015
2SSGA, as of 8/27/2015
This article was written by Jim, Executive Vice President of State Street Global Advisors and the Global Head of SPDR ETFs and Head of Intermediary Distribution in the United States.