Best Practices of ETF Trading

Sep 30, 2020 03:36 AM ET
Best Practices of ETF Trading

Many people, as they hear the term ETF liquidity and trading, they immediately have the conception of complexity in their minds. Nevertheless, what stays constant is the fact that when someone is buying or selling an ETF, they wish to carry out their trade as effectively as possible. They are more liable to do so even when markets are volatile, that is if they are aware of a few ETF trading best practices.

Let us take a look at some of these basic best practices and aspects for ETA trading:

Consider Market Volatility

Market conditions can have an impact on bid-ask spreads or the difference between the price at which an investor can sell a security and a higher price necessary to buy the same security. For the duration of the volatile periods, a smaller number of shares may be listed at best-bid and best-ask prices escalating the importance of utilising the appropriate order type and monitoring your trades.

Stay on Top Of The News

ETFs can momentarily trade at a premium or a discount to the net asset value of the underlying holdings. Such swings can be an outcome from distinct events including the release of economic indicators or statements from central banks as well as earnings and other news from companies that are great constituents of an ETF and its benchmark.

Understanding Liquidity

Always remember that ETF shares can be redeemed at any time or created at any time which is why the liquidity of the underlying securities in the redemption/creation basket matter most. When it becomes difficult to treat the underlying securities the market makers cost may amplify which results in wider bid-ask spreads than customary or compared with ETFs in other asset classes. Primary market liquidity is the name given to the liquidity of underlying securities whereas secondary market liquidity is referred to as an ETF’s ADV.

When International Markets Are Closed?

It is typically considered ideal to trade international ETFs during the time periods that overlap with the trading hours of the underlying securities’ local markets. Here is an example for better understanding. The prices of international ETFs traded in Europe lean to be closer to the value of underlying securities and usually trade with narrow bid-ask spreads when their respective markets are open and coincide with European trading hours.

When Bond Markets Are Closed?

When the bond market is closed but the stock market is open, ETFs trade like shares, even when they aspire to track bond dices. So the fixed income ETFs trade at any time when the stock market is open. That is even if the bond market is closed which is why the market maker doesn’t have a pricing source. A good example can be a European government bond ETF that is listed in London will persist to trade while the LSE is open even if the European markets are closed.


Best Practices of ETF Trading

Use Limit Orders

What a limit order does is that it allows you to set the price at which you buy or sell an ETF. In case you use a market order you end up paying more or receiving less than you would have considered necessary. On the contrary to that, using a limit order means the shares may not be available at your specific price at the same time and not all of your trades may be executed.

Some Common Order Types

Stop order: 

In this type of order, you set a stop price which is where you automatically buy or sell. So when the market hits the stock price your stop order becomes a market order and the price you then get is the best available current price. That price may have altered (good or bad) in the moments after your stop price triggered your market order. The main objective when placing a stop order is trying to limit a loss or protect a profit.

Limit order: 

In a limit order, you set a price and execute your trade only if shares are available at that price or better. Its objective is to protect you from executing a trade at an unwanted prize.

Market order: 

When you place a market order your objective is to make a trade quickly that is buying or selling immediately at the best available current price.

Stop-limit order: 

Just like a stop order, you get to set the stop price and in addition to that, a limit price as well. When you place the stop-limit order your objective is to limit a loss or protect a profit without the uncertainty of a market order.

Incorporate the Use Of A Block Desk

A block desk can be utilised as a trading tool and a network of relationships to enable you when you place a large order. Following are some of the things that your block desk can do –

  • It can trade in increments to deal with any effect that large trades could have on the prices.

  • It can obtain a quote to execute the entire trade.

  • It can create and redeem ETF shares directly with the ETF issuer.

  • It can review the depth of interest in an ETF prior to placing a trade. You may be able to figure out how many shares are available at best-bid and best-ask prices from your trading screen. This tool can also evaluate the additional availability of shares.

Observe the Clock and The Calendar

Paying attention to the clock and calendar helps because spreads can widen at certain times every day or on certain specific days of the year.

Observe the Clock and The Calendar

Market’s open

At the opening of the market, some of an ETF’s underlying securities may not initiate trading. This is possible due to perhaps material news about security. In situations like that the market maker cannot price the ETF with certainty.

Market’s Close

There are very few firms that make markets in EFT at the market’s close. This is so because a smaller quantity of shares may be listed for purchase and sale than at other times of the day.


Remember these basic best practices and aspects and you will be able to trade with the utmost efficiency while buying and selling ETFs.


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