As more investors look into the benefits of exchange traded funds, it is important to understand that ETFs are not like the traditional funds that many have used over the decades.
“One of the most important things is to know the average daily volume,” Shana Martin, ETF Product Manager for Nationwide Fund Advisors, said at the 2018 Morningstar Invest Conference. “I think a lot of advisors look at this as a key metric with learning how to trade the ETF, and you see a product that has a high average daily volume, or ADV, that product you can ultimately use that as a very liquid, very quick trading vehicle for a tactical movement.”
However, there are also a number of ETFs that trade with lower volumes and exhibit wider bid/ask spreads that may cut into overall returns when investors try to execute a trade. To limit these potential negative effects of trading with ETFs, investors and advisors will have to keep a few pointers in mind.
“Don’t trade at the open or close. That’s when the spreads really widen out because there’s a lot of price discovery at those time periods,” Martin said.
Investors should also refrain from market orders and use limit orders to better control their trades.
“Limit orders place price as a priority, so you are signalling to the marketplace that that’s the highest price you want to pay for the ETF’s share, but something to remember is that as price is a priority, quantity is not. So make sure you maintain and look at that order to make sure it’s executed properly,” Martin added.
Additionally, Martin explained that large investors may also work with a capital markets team or a brokerage firm’s trading desk to execute large orders in ETFs with low trading volumes in an efficient manner that does not affect the market price.
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