As Vanguard and other industry participants discuss potential systemic enhancements, it may be an opportune time to reexamine your trading practices to help protect clients from being affected by market extremes. We all learned in elementary school a simple reminder about fire safety: Stop, drop, and roll. Well, there’s a similar way to think about safety with ETF trading: Limit, block, and call.
Limit. When you trade ETFs, consider using limit orders, not market orders, as your default trade type. Whether the markets are calm or volatile, protecting your trade by using a limit order that defines your price is sensible and smart. While a market order ensures the trade’s execution, it doesn’t ensure the price at which it will execute. How comfortable are you with explaining to a client why an ETF trade was executed at either the high or the low price of the day or a price that was way off from the value of the ETF’s underlying assets? So the next time you are about to put in an order for a client, stop to think about whether you are willing to roll the dice using a market order. The benefit of protecting your price by using a limit order oftentimes outweighs the benefit of ensuring immediate execution with a market order. Using a marketable limit order again reduces the risk of missing an execution, with the added protection of price surety.
Block. If your order is of sufficient size (usually 10,000–20,000 shares or more), you should consider sending the order to your broker’s block desk. In many cases, using a market order for large trades creates additional transaction costs, such as market-impact costs, or depletes the depth of the ETF’s order book, resulting in a poor and costly execution. However, a block desk can easily source additional liquidity for you in any ETF—regardless of how large the trade may be or how little average daily volume an ETF may have—to help ensure execution at a fair market price and in short order.
This article was written by Doug Yones, head of Vanguard’s domestic equity indexing and ETF product management.