Making the most of ETFs means trading efficiently and appropriately. At the Canadian ETF Association (CETFA), we recognize that questions about best practices for trading ETFs continue to be common. To help, we have compiled eight key trading tips to consider when buying or selling ETFs.
1. Use limit orders, not market orders
Limit orders allow you to set the price at which you are willing to trade, while market orders will be executed at the current market price as soon as shares are available. Market orders present the risk of paying an undesirable price, as the market price can change due to events that are out of your control. Limit orders provide investors with greater control over their execution price.
2. Do not trade when the market is volatile
The market tends to be particularly volatile during the first and last 15 minutes of the trading day so, generally speaking, it’s a good idea to avoid trading during that time. In the morning, ETFs are going through a “price discovery” phase — comparing the previous day’s closing price with the current net asset value price, and, at the same time, factoring in changes to the value of the underlying holdings. At the end of the trading day, large investors may begin to hedge their positions, which can result in rapid price changes and widening bid/ask spreads. Overall, trading ETFs during market volatility is best avoided because it can cause the bid/ask spread to widen.
3. Trade ETFs with international exposure when underlying markets are open
Most international markets close by the afternoon for investors in the Toronto region. If the market is closed, then market makers are pricing based on estimates and assumptions, as they cannot hedge until the following day. Market makers do not know exactly what the price is going to be when those markets open, and whenever there is uncertainty, you can be sure that some measure of risk premium is attached to the price of the security.
4. Watch the bid/ask spread
At any given time, there are two prices for an ETF: the price at which someone is willing to buy (the “bid”) and the price at which someone is willing to sell (the “ask”). The difference between these two prices is called the “spread.” The spreads exists because, as in any open market, investors try to negotiate the best price. Spreads widen and narrow for various reasons. Popular ETFs with strong trading volume may have narrower spreads, while less popular, thinly traded ETFs may have wider spreads. However, the underlying market is typically the best determining factor or indicator of spreads. It’s important to remember that your quote may not provide you with complete volume data (see below for more on this).
5. Your ETF data may not be complete
In Canada, the majority of investors and advisors do not have the ability to see an ETF’s consolidated bid/ask spread or trading volume. This means that advisors are not seeing every available quote, all the trading volume or the existing liquidity on various exchanges. One exchange could be posting more volume and a better price, but you may not be aware of that based on the available data. This inability to see the complete picture can drastically affect how you view an ETF’s liquidity and trading volume.
6. Don’t forget about holidays
Many ETFs that trade on Canadian stock exchanges hold U.S. and other international securities. There may be days when the ETF will trade on a Canadian exchange even though it is a holiday in the country where the underlying securities trade. This can cause bid/ask spreads to widen.
7. Be aware of political and economic announcements
Macroeconomic news, political shifts or even tweets from the current U.S. president can introduce greater market fluctuations, affect the price of securities and potentially widen bid/ask spreads for ETFs.
8. Remember, you’re human
Behavioural finance is more than just a fancy term — it has a real effect on investor behaviour. The key is to keep your emotions in check and focus on quantitative analysis and your long-term plan.
When trading ETFs, it’s important to keep the bigger picture in mind. Recognizing and understanding the various elements that could impact your trades can help you make the most of your trading practices. When in doubt, speak to the ETF provider, as they will be happy to assist and answer any questions you may have.