Before buying or selling an exchange-traded fund (ETF) it’s a good idea to consider trading methods that can save you money and improve your returns. Here are a few suggestions on trading ETFs that could help you to increase your bottom line.
ETF Tip #1 – Don’t Place Orders Near the Market Open or Close
The difference or spread in an ETF’s intraday price and the fund’s net asset value (NAV) is often the greatest at the market’s open and close. For example, at the open, these pricing differences may persist until all stocks open and start trading for the day. Towards the 4PM close, market makers begin to balance their books which can trigger wider spreads and increase an ETF’s volatility. Restricting your ETF buy or sell orders to 30 minutes after the market’s open or 30 minutes before the market’s close can help to alleviate spreads and pricing discrepancies.
ETF Tip #2 – Watch Out for Volatile Days
Volatile trading sessions can impact your ETF investments from two perspectives. First, your ETF’s share price and NAV may vary from the value of the underlying securities. Second, the bid/ask spread of your ETF’s share price may widen considerably, thereby increasing your trading costs. (The bid/ask spread is the difference between the lowest seller’s ask price and the highest buyer’s bid price.) It may be best to avoid trading your ETF shares on days with wild price swings.
ETF Tip #3 – Beware of Related Trading Hours
If you’re planning to buy or sell an ETF that owns international or emerging markets stocks, try timing your order when trading in those underlying shares are open in their respective foreign markets. For example, European stocks traded on the Euronext are open for trading until 10:30AM (EST). The London Stock Exchange is open until 11:20AM (EST). Foreign stock markets in Australia, China and Japan do not overlap with trading hours in the U.S. stocks.
Likewise, investors that use commodity ETFs should be aware that trading hours in commodities and the U.S. stock market are different. Contracts on metals at the Comex Metals Exchange are open from 8:20AM-1:30PM (EST) while grain contracts at the Chicago Board of Trade are open from 10:30AM to 2:15PM (EST). Timing your ETF trades while the underlying commodities markets are open may help to reduce pricing discrepancies between a commodity ETF and its underlying commodity contracts.
ETF Tip #4 – Avoid Needless Trading
The cost of buying or selling ETFs is impacted by the frequency of trades executed and the commission cost of each trade. These costs can be controlled by limiting the frequency of your trades and by choosing a broker that offers the most competitively priced commissions for the level of services being offered.
In some cases, investors that systemically invest a fixed amount of money on a monthly or weekly basis may be better off in an index mutual fund rather than an index ETF. Investing in an index mutual fund could help to avoid the commissions associated with fund purchases, so long as there are no transaction fees levied by a broker to buy or sell the fund.
ETF Tip #5 – Keep Track of Distribution Dates
Even though most ETFs limit the amount of tax distributions, there are exceptions. Over the past few years several leveraged and short ETFs had record tax distributions that caught some investors by surprise. In one particular year, a leveraged ETF had a short-term capital gains distribution that was 86% of the fund’s NAV. Such extremes can be caused by soaring prices in the ETF’s underlying derivative contracts, followed by massive shareholder redemptions which force the ETF’s manager to sell its positions and pass on the gains or losses to remaining shareholders.
Generally, most ETF providers will distribute their annual tax gains or losses during the fourth quarter of each year. While some companies may announce tax distribution dates a few weeks in advance, others may only give a few days notice. Stay alert — if a certain ETF is expected to have a large tax liability and you already own it in a taxable account, it may be wise to sell the fund just before the distribution date. On the
other hand, if you’re thinking about buying an ETF with a large pending tax liability, it may be in your best interest to delay the purchase of the fund until after the distribution record date.
ETF Tip #6 – Choose ETFs with Decent Volume
Try selecting ETFs with good trading volume. Even though high trading volume doesn’t necessarily guarantee liquidity, it can contribute to your ETF having tighter bid/ask spreads. You also have a better chance of seeing your limit orders filled more quickly. For similar ETFs with similar annual expense ratios, choosing the fund with better volume is likely to translate into a cost savings difference.
ETF Tip #7 – Pre-Determine Your Buy/Sell Price Points
For ETF purchases, consider using limit orders. This will spell out the exact share price you’re willing to buy an ETF at. The risk of limit orders is that your ETF’s share price increases in value and your order goes unfilled.
Knowing when to sell your ETF shares is never an easy decision. However, one easy way to protect your ETF portfolio during a declining market is to use a stop-loss order. This type of order is automatically triggered when your ETF declines to pre-determined price. A stop-loss order can help you to minimize market losses. A trailing stop-loss order ratchets up the stop-loss price as your ETF’s price increases in value.
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