Exchange-traded funds make it easy for investors to buy and sell funds just like a stock. Their generally low fees can help boost returns. But when it comes to trading ETFs, there are nuances for investors to consider that can help achieve an optimal outcome.
Use Limit Orders
When buying or selling an ETF, investors typically have two options for submitting orders: limit orders and market orders. Market orders execute a buy order almost instantaneously at increasing prices (or decreasing prices for a sell order) until the entire order quantity is filled. Limit orders allow investors to choose the maximum price at which they buy or the minimum price at which they sell. They’re the best way to avoid bad trades.
Most of Canada’s 1,500-plus ETFs are small and potentially expensive to trade, and market makers can take advantage of orders in ways that harm investors. Limit orders prevent this. The tradeoff is that they may not execute. Aggressively priced limit orders are more likely to be filled, while the market may move away from nonexecutable limit prices, leaving such orders unfilled.
Don’t Trade Near the Open or Close
The first minutes after the opening bell are a time for discovery, when traders incorporate all the orders placed since the prior close. That makes it difficult for market makers to accurately price ETFs, but the kinks usually get worked out in the first 15 minutes. By then, bid-ask spreads have tightened and ETFs are easier to trade.
Likewise, market makers widen their quotes to limit their risk as the market approaches the close because they don’t want to get stuck with a bad trade. Therefore, it’s best to avoid trading in the last 15 minutes of the day.
Trade When the Underlying Market Is Open
In recent years, cryptocurrency markets have touted their 24/7 trading hours, and a few brokerage firms have added night trading for customers. Some may like this flexibility, but trading outside of normal market hours could be costlier. Canadian ETFs should be much easier to trade when the Canadian market is open.
Given the overlap of time zones, investors can easily trade US-domiciled ETFs or ETFs holding US stocks during the same market hours. But use some caution when trading ETFs holding stocks or bonds from other markets. They’re best traded when there’s an active market for the stocks they hold. For example, it’s best to trade Vanguard FTSE Developed Europe All Cap Index ETF VE in the morning, when European markets are still open. Market makers have an easier time keeping ETFs in line with their underlying stocks when those stocks are open for trading. Other markets, such as Japan, may not have overlapping market hours with Canada. Limit orders are the best approach in those instances.
Phone a Friend
Investors making large trades can potentially save substantial execution costs at the expense of spending some time on the phone with a broker, a representative of an ETF provider’s capital markets team, and/or a market maker. There is no hard and fast definition for a large trade. A general rule of thumb would place any trade that accounts for 20% of an ETF’s average daily volume or more than 1% of its assets under management as fitting this description.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
