We know that investors are always hungry for investment advice, including information on exchange-traded funds ( ETF in English/FNB in French ). Here are 10 tips for investing in ETFs .
“No Limit” is a game of poker, not an investment strategy
You should consider using limit orders, not market orders. These can be useful when time is of the essence and price is of secondary importance, or when there is a lot of liquidity.
Investors using market orders want to fill their entire order as quickly as possible. For large, highly liquid ETFs that trade alongside their underlying securities, market orders will likely allow for quick execution at a good price.
But there are smaller or less liquid ETFs, and there are also ETFs that trade at a lag with their constituents. Limit orders are used to guarantee favorable execution from a price point of view. A buy limit order will net the buyer a price lower than or equal to the limit price, while a sell limit order will be executed at a price higher than or equal to the limit price.
Avoid trading at the open, close or during the auction period
For ETFs listed on the Toronto Stock Exchange, this means at the very least avoiding trading before 9:15 a.m. or after 3:45 p.m. At these times, market makers may not monitor the market as closely and some underlying stocks may not be trading, making it more difficult for the market maker to calculate an accurate price.
Check the gap between supply and demand
If the gap between the bid price and the ask price is large, it may indicate that something is wrong, and it may be worth delaying your trade or digging deeper. It is also worth watching the spread between the bid and ask prices to see if it is unstable, that is, if it narrows and widens frequently. If so, this is a sign that market makers are adjusting to risk and caution is in order.
Be careful when making trades while the underlying securities are not open for trading
ETF trading volumes are expected to be significantly higher and spreads between bid and ask prices will generally be lower when the underlying stocks are also traded and prices are transparent.
Use the tools available
ETF providers offer tools like intraday net asset value, or iNAV, which can help determine if an ETF is trading near its net asset value. Although there is no guarantee that iNAV is an exact representation of NAV, it is a useful indicator. If there is one, check the iNAV before trading.
Check trading volumes and ETF sizes
An ETF’s size and on-screen trading volume don’t tell the whole story, but they are an important part of it. The liquidity of the underlying assets is arguably most important, as the market maker can create or redeem ETF shares to balance supply and demand, as long as the underlying market is liquid. However, an ETF’s size and on-screen volume is worth watching, especially for ETFs whose underlying assets trade outside of Canadian business hours.
For example, for global equity ETFs, the on-screen volume may be greater than for ETFs whose assets trade during local hours. Generally, the larger the size of the ETF, the less likely investors will have problems trading it.
It’s hard to make a bad trade if you don’t make trades
Ask yourself: is there anything unusual here? Is the ETF price significantly different from yesterday, or even a few minutes ago? Is the ETF price stable while the underlying markets are rising or falling? Are the markets experiencing extraordinary volatility, was there a same-day distribution but the price has not decreased accordingly?
If so, you may need to do more research or be patient before making a trade. That said, sometimes it’s better to trade without considering transaction costs, if you realize your thesis was wrong. Use common sense in making decisions, avoid emotions, and rely on your intellect and good advice.
Stop-loss strategies may not stop your losses
Stop-loss strategies can lose more money than they save, especially during market turbulence. For example, during the volatility of 2015 in the United States, the market crashed due to a momentary lack of liquidity, which triggered stop-loss orders. As some of these stop-loss orders were market orders, they were executed at whatever price was available, and with limited liquidity at the time, which could have caused prices to fall even further.
Investors with stop-loss orders may have sold at the bottom. We advise you to exercise caution in the use of stop-loss type strategies, particularly if they are triggered automatically or if they use market orders. Price alerts can be used instead.
When in doubt, speak up
Contact the ETF provider or market maker if anything seems odd or you are unsure about something. The ETF provider can answer questions about trading an ETF and explain anomalies.
Remember – it all depends on your investment strategy
Long-term investors will probably have less to worry about when trading ETFs. If a volatile market causes bid-ask spreads to widen, the long-term investor can handle it. If it is necessary to make trades, he can wait until the volatility has subsided to execute them.
In contrast, a short-term investor may be forced to exit a trade quickly, regardless of the cost. The cost of a panic trade can be very high when spreads are widened, and investors will need to carefully assess whether it is more important to trade and incur the cost, or whether they can afford to wait.
If an ETF doesn’t help you achieve your investment goals and strategy, or doesn’t match your risk tolerance and investment horizon, it’s unlikely to be the best choice for you, even if the investment proposition seems attractive.