Invesco Canada blog

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Christopher Doll | January 16, 2016

ETF trading: A guide to best practices

1. Use limit orders

Limit orders offer advantages over market orders because they provide certainty on the trade price and act as a guard against overpaying. A market order may be effective when placing small trades in highly liquid ETFs, but there is a risk that it could sweep indiscriminately through the order book, leading to an undesirable price. A limit order, however, sets the price at which you are willing to transact. The closer your price is to the bid or ask, the greater the probability that your sell or buy will be executed. The use of a limit order is not without risk, as your trade may not be executable at the specified price.

2. Don’t trade near market open and close

In general, it may be prudent to avoid trading within the first and last 15 minutes of the trading day. Not all of an ETF’s underlying securities may have started trading within the first few minutes of the trading session, in which case the market maker cannot accurately price the ETF. As the market close for the underlying securities nears, market participants seek to limit their risk. With fewer market makers willing to post prices, spreads tend to widen.

3. Watch for volatility

Increased market volatility in underlying securities prices may cause an ETF’s bid-ask spread to widen and for the ETF to trade at a larger premium or discount. In these fast-paced environments, seeking trading assistance may be prudent and using limit orders is advisable.

4. Look at spreads, not volume

An ETF with substantial trading volume may appear to offer superior liquidity, but it’s not the best measure. An ETF’s historical and current bid-ask spread is a better indicator of liquidity because it includes the liquidity of its underlying securities.

5. Use bids and asks to determine current market price

Using the price of the last trade is problematic, as the data may be stale and not representative of the current market environment. The current bid and ask prices better reflect the fair value of any security. In particular, the bid and ask prices offered by market makers are representative of the weighted average of the basket of securities in the ETF itself. Be aware that the market maker bid-ask may not be the top of book bid-ask. The market maker bid-ask spread serves as goal posts to manage the price of the ETF. Other buyers and sellers in the market are usually within this range.

The information in this document is for educational purposes only, and does not constitute investment advice or recommendation, or an offer to buy or sell any investment security. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed.

6. Watch the clock for international ETFs

If possible, it is preferable to trade international ETFs during the trading hours of the underlying securities. Prices of international ETFs traded in Canada tend to be closer to the value of the underlying securities, with a narrower bid-ask spread, when their respective markets are open and overlap with domestic trading hours. Note that Asia-Pacific markets are always closed during North American trading hours. Most European markets close between 11:00 a.m. and 11:30 a.m. Eastern Time. The closing bell does not stem the flow of information that can affect the value of foreign-listed securities. A price of a TSX-listed international ETF whose local market is closed may reflect new information that may seem to represent a greater premium and discount relative to the ETF’s stated NAV, which reflects the last quoted prices of the underlying securities.

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The information in this document is for educational purposes only, and does not constitute investment advice or recommendation, or an offer to buy or sell any investment security. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed.

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