Trading ETFs

The table below summarizes some of the common differences between ETFs and noload funds:

Challenges of Trading ETFs

There are trading costs involved in buying and selling ETFs, and, because a fee is charged for each trade, these are proportionately greater for smaller purchases. If you trade ETFs fairly actively or hold a large number of small positions, you could wind up paying more than you’d expect.

Tracking Issues

Most ETFs are index-based, but some ETFs have difficulty aligning their performance with that of their underlying index. At times, investors may find they aren’t getting the same returns as the index they’d hoped to track.

Be a Smarter ETF Trader

Of course, this doesn’t mean that you should avoid ETFs, but we do suggest putting some additional time and effort into trading ETFs.

When you’re preparing to trade an ETF, look for two key pieces of information: trading volume and the bid/ask spread.

  1. Trading volume is the number of shares bought and sold that day and it can vary widely. With more actively traded ETFs, such as PowerShares QQQ Trust (which tracks the NASDAQ 100 Index) volume can exceed 100 million shares a day, making it very easy to get a fair price.

    Volume under 40,000 shares in a day is quite low, and indicates that there is not much liquidity in that ETF. If you are buying 500 shares in an ETF with low volume your trade could actually move the price up. In June 2009, Guggenheim Multi-Asset Income Index (CVY), for example, traded less than 20,000 shares in a day. This indicates it might be difficult to exit that fund when the time comes to sell.

  2. Consider the bid-ask spread. This is the difference in the lowest price a seller is willing to accept and the highest price a buyer is willing to pay as of the last trade. Consider this spread to be part of the cost to you, the investor. In big, widely traded ETFs spreads are miniscule, a penny or two at most. In small, thinly traded ETFs the spreads can be substantial, five or ten cents or more.

    When the spread is wide, consider placing a limit order, naming a price somewhere below the asking price. This will make it less likely that you will overpay for the shares. However, it does mean your order may not be filled.

  3. Avoid trading an ETF at the open. In those first few minutes of trading price swings can be wild and the spread between the bid and ask price can be very wide (1-3% spreads are common). By waiting 30 minutes or so, you’ll allow the ETF to come more closely in line with its underlying index. Often , ETF portfolios trade right in line with the underlying index during the last five minutes of trading.