Exchange traded funds (ETFs) share a lot of similarities with managed funds, but trade like stocks. They are a diverse, low-cost and tax-efficient way to invest. Discovering how to trade may allow you to take advantage of price movements and seek the best execution.
Closing Price vs. Net Asset Value (NAV): ETFs are traded on the exchange during the day, so their price fluctuates with the market supply and demand, just like stocks and other intraday traded securities. The NAV is calculated by the standard methodology in the Product Disclosure Statement (PDS) and based on the underlying securities’ closing prices. Hence the ETF’s closing price could diverge from the official NAV and is therefore not the official valuation of the ETF.
Liquidity is not limited to what you see on-screen/on exchange: ETFs are as liquid as their underlying market. Unlike individual stocks, which usually have a fixed supply of shares in circulation on the secondary market, ETFs have an open-ended structure and can be created/redeemed based on investor supply and demand.
We believe that in order to make use of these products as effectively as possible and to ensure successful, cost-effective execution, there are a number of considerations that you should bear in mind when employing ETFs. Below are our top tips.
Always use a limit order. When buying on an exchange, limit orders provide better price control, consider using limit or stop-limit orders (especially in volatile markets).
Try to trade when the underlying market is also trading. For Australian investors, it may be the case that the underlying market is closed. For example an investor wishing to purchase the SPDR S&P 500® ETF, which trades in US equity markets. When buying an ETF where part or all of the underlying security’s market is closed, it is best to time the execution when a maximum of the underlying securities trade. All else being equal, this may help having lower bid-ask spreads at this point.
Try to avoid trading in the first and last 10 minutes of the trading day. When markets are opening and closing, there is generally more volatility in prices, and as a result wider market makers’ spreads.
Open, close and auction periods are often governed by specific rules. It is prudent to familiarise yourself with these rules. Placing a trade during these periods should generally be avoided unless the investor anticipating the trade is comfortable with those rules.