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 1,900 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, you might consider the iShares® Core S&P 500 ETF (IVV) which seeks to track the investment results of the S&P 500® Index. If you were bullish on consumer buying trends, you could look at the Fidelity MSCI Consumer Discretionary Index ETF (FDIS), which seeks to provide investment returns that correspond to the performance of the MSCI USA IMI Consumer Discretionary 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 tolerance, 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 Services Group believes can help you hold down transaction costs and boost your chances of success.
1. Pay attention to the bid-ask spread
Not all ETFs are equally liquid (i.e., can be easily bought and sold). Of the 2,158 ETFs in the US market, approximately 1,700 trade on relatively low volume—defined as less than $25 million traded on average per day (see ETF volume chart). Understanding how liquid an ETF is can be very important because it can influence what you'll pay to buy or sell it.
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 lose 50 cents a share plus commissions. This would impact your realized performance, and for investors who trade large volumes of shares, those differences can add up.
Of course, trade size may impact the spread as well—the listed spread is not necessarily constant for all trade sizes. Size refers to the number of shares offered at the bid and ask price, and it is typically quoted in hundreds (see screenshot). For example, if a buyer purchased 100 shares of an ETF at $27.19, the bid size would be 1 (100/100). If, in a different transaction, a seller sold 2,000 shares at $30.15, the ask size would be 20 (2,000/100).
Spreads should also be analyzed as a percentage of NAV. In fact, this percentage ($ spread/$ NAV) can be more meaningful than simply the price range of the spread because it puts the spread in context.
You can find bid-ask spread, trade size, and NAV information on Fidelity.com on an ETF’s snapshot page.
2. Consider limit orders
Particularly for thinly traded securities, where even small orders have the potential to move an investment's price, consider using limit orders—where you set a specific price at which you are willing to buy or sell. 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 timeframe 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 Services Group suggests that, due to observing 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. 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's ETF Services Group suggests that you consider utilizing limit orders, while avoiding market orders, including not using "Market on Open" (MOO) and "Market on Close" (MOC) orders.
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ETFs are subject to market fluctuation and the risks of their underlying investments. ETFs are subject to management fees and other expenses. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than their NAV, and are not individually redeemed from the fund.
Exchange-traded products (ETPs) are subject to market volatility and the risks of their underlying securities, which may include the risks associated with investing in smaller companies, foreign securities, commodities, and fixed income investments. Foreign securities are subject to interest rate, currency exchange rate, economic, and political risks, all of which are magnified in emerging markets. ETPs that target a small universe of securities, such as a specific region or market sector, are generally subject to greater market volatility, as well as to the specific risks associated with that sector, region, or other focus. ETPs that use derivatives, leverage, or complex investment strategies are subject to additional risks. The return of an index ETP is usually different from that of the index it tracks because of fees, expenses, and tracking error. An ETP may trade at a premium or discount to its net asset value (NAV) (or indicative value in the case of exchange-traded notes). The degree of liquidity can vary significantly from one ETP to another and losses may be magnified if no liquid market exists for the ETP's shares when attempting to sell them. Each ETP has a unique risk profile, detailed in its prospectus, offering circular, or similar material, which should be considered carefully when making investment decisions.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917