Exchange-traded funds (ETFs) can be powerful investing vehicles. They trade intraday like stocks. Yet, like mutual funds, they are baskets of investments (e.g., stock ETFs hold a basket of stocks) representing the entire market or specific segments of it.
With more than 2,000 ETFs available to trade on Fidelity.com representing stocks, bonds, and commodities, including passive and actively managed strategies, ETFs offer a wide variety of options allowing investors to implement a short- or long-term strategy. If you were looking to invest in the broad US stock market, for example, one opportunity of many that you might consider is the iShares® Core S&P 500 ETF (IVV), which seeks to track the investment results of the S&P 500® Index. If you were interested in an ETF that holds stocks that pay dividends, you could look at the Fidelity High Dividend ETF (FDVV), which seeks to provide investment returns that correspond to the performance of the Fidelity Core Dividend Index.
Once you've determined your investment strategy, which may be implemented in whole or in part through the use of ETFs, you still need to do your homework before investing in an ETF. Among the key factors to consider:
- The characteristics of the ETF (asset class, desired exposure, risk, active or passive, etc.)
- The benchmark it seeks to track and its track record at doing so (tracking error)
- The underlying holdings (the specific investments the ETF provides exposure to)
- Liquidity (a factor that can impact an investor's ability to buy and sell at a specified price)
- Trading costs (see more on this below)
After you have done your research and determined that an ETF fits into your investment strategy, here are 3 trading tips that Fidelity's ETF Management & Strategy Team believes can help you hold down transaction costs and boost your chances of success.
1. Pay attention to the bid-ask spread
One way to evaluate a particular ETF is to look at its "spread," which is the difference between the price at which a buyer is willing to buy (bid) and a seller is willing to sell (ask). Tight spreads are typically $0.01–$0.02, while wider spreads can be $0.05 or more.
In general, smaller spreads are better, but context is key. Ask yourself: In addition to considerations of performance, concentration, tracking error, fees, benchmark, and premium/discount, is the spread expensive relative to other similar investments? For instance, a $0.05 spread may not be unreasonable for less liquid investments like certain types of fixed income securities or for stocks traded on a small foreign market. However, that same spread would be high for a very liquid investment that has much more volume, like an ETF that tracks the S&P 500, where spreads can be as thin as $0.01.
Fractions of a penny on a trade may sound negligible, but they matter. Let's say the bid for an ETF is $50 and the ask is $50.50. If you bought the ETF, then wanted to turn around and immediately sell it, you would incur $0.50 per share in spread costs. This would impact your realized performance, and for investors who trade large volumes of shares, those differences can add up.
It's worth noting that a broker, such as Fidelity, may work hard to get the best execution price for your trades. Price improvement occurs when your broker is able to execute at a price that is better than the displayed National Best Bid or Best Offer (i.e., below the best offer for buy orders or above the best bid for sell orders). For example, in the 4th quarter of 2018, Fidelity improved on more than 90% of all ETFs traded, saving $13.26 on average for a 1,000-share order.*
You can find bid-ask spread, trade size, and NAV information on Fidelity.com on an ETF’s snapshot page, as well as learn more about price improvement advantage here.
2. Consider limit orders
Not all ETFs are equally liquid (i.e., can be easily bought and sold). Of the more than 1,800 ETFs in the US market, approximately 1,350 trade relatively low volume—defined as less than $5 million traded on average per day (see Many ETFs have relatively low trading volume). Understanding how liquid an ETF is can be very important because it can influence your use of limit orders.
Limit orders are a particularly valuable tool for trading thinly traded securities, where even small orders have the potential to represent a high percentage of an ETF's average daily volume and, as a result, impact the prevailing market price. By using limit orders—you set a specific price at which you are willing to buy or sell that ETF—you can better control your execution price. By contrast, with a market order, you get the prevailing market bid or ask price.
A buy limit order is usually set at or below the current market price, and a sell limit order is usually set at or above the current market price. For an ETF trading at $25.50, for example, a buy limit order might be set at $25.40 and a sell limit order at $25.60.
Of course, if you set your limit too high for a sell order, or too low for a buy order, you risk missing the trade in the time frame you may want. This could result in paying a higher price than you want or receiving a lower price than you want if you are still looking to execute the trade.
If you are entering a trade on Fidelity.com or Active Trader Pro®, use the drop down menu to choose Limit Order versus Market Order. For more on trading order types, read: Know your trading orders.
3. Avoid trading around the market open and close
Lastly, Fidelity's ETF Management & Strategy Team suggests that, due to the potential for increased ETF price volatility near the opening and closing bell, investors may want to consider avoiding trading at these times. When volatility is higher, the range of publicly quoted bid and ask prices (known as depth of book) can be limited. In addition, large buy or sell orders can easily overwhelm the available depth of book, creating adverse price dispersion. That makes it a little harder to be matched up with your desired price, compared with market hours when there is less volatility and greater depth.
However, if you must trade an ETF near the market's open or close, Fidelity suggests that you consider utilizing limit orders, while avoiding market orders.