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 1,580 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 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 the global consumer, 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. For more specific details on what ETFs are and how you might incorporate them within your portfolio, read Special report: ETFs. Among the key factors to consider:
- The type of 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
After you have done your research and determined that an ETF fits into your investment strategy, here are three 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. Of the 1,714 ETFs in the U.S. market, approximately 1,600 trade on relatively low volume—less than $25 million per day in 2016 (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 determine how liquid the market is for 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: 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 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 could impact your 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 and a seller sold 2,000 shares at $30.15, the bid size would be 1 (100/100) and the ask size would be 20 (2,000/100).
Spreads should also be analyzed as a percentage of NAV. In fact, this percentage ($ 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 current 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.
Fidelity’s “best execution” pledge
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 or receiving a lower price 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.
However, if you must trade an ETF near the market’s open or close, Fidelity’s ETF Services Group believes you may want to consider utilizing limit orders, while avoiding market orders, including not using “Market on Open” (MOO) and “Market on Close” (MOC) orders.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917