Okay, we’ve written a lot about exchange-traded funds (ETFs), and even we’ve compiled an introductory guide (click here) to what they are and how you can use them to help build a diversified investment portfolio. In this short article, and with the help of our partner HANetf, we’ll get to grips with the thorny issue of buy and selling this collective investment product.
The basics (again)
Exchange-traded products (ETPs) and exchange-traded funds (ETFs) are a type of investment fund or tracker that provide exposure to certain stock sectors, commodities, bonds, or currencies. Like other passive investments such as index tracker funds, ETPs and ETFs are traded on an exchange like shares, with literally hundreds on offer trading on the London Stock Exchange.
ETFs trade just like regular shares that are listed on a stock exchange. You can buy and sell them through a stockbroker, online share trading platform, or via your financial advisor.
You can find the product you wish to trade by searching for the product name or ticker. All ETFs will have a product name and a ticker symbol along with a unique identifier and ISIN number. For example, the Emerging Markets Internet and E-commerce ETF has the ticker symbol ‘EMQQ’. You can find the ISIN and identifiers on the ETF’s fact sheet on the issuer’s website.
There are two main ways in which you can place orders: market orders and limit orders.
The difference between the two is important because it can have an impact on the price you might receive. We discuss each of these in a little more detail below.
If your order is executed, typically it will settle two days after the trade date. This is the process of the ETF being transferred to the buyer’s account and the cash being transferred to the seller or vice versa.
A market order is where the broker/platform sends your order to the market to be executed as quickly as possible. Your order is likely to be executed immediately as there should always be a market maker in our ETFs showing prices at which they are willing to buy and sell.
However, market orders are not always recommended as the price you receive may vary significantly from the price you may have seen on-screen just before you hit the execute button.
There are a few reasons for this, but some examples are:
The market is very volatile and the price moves in the time between your order being placed and reaching the market.
The market maker has just sold some shares and your order hits the market just as they are refreshing their prices such that you get executed at the next best price in the market which is significantly higher or lower than the market and your expectations.
A limit order ensures that you get a price for the ETF which is within the range of your maximum or minimum price that you are willing to pay or receive (your limit). It offers you some protection from sudden market moves so this is the way in which we recommend you place the majority of your ETF orders.
The broker/platform that you use may allow you to specify how long you want the order to remain live. For example, the market price may never reach your limit as the price moves away from your limit order price.
In some instances, you may not want your order to remain live while you are not monitoring the market. Limit orders can be set for the day (GTD) or good till cancelled (GTC) which will remain in the system until you cancel them.
A quick look at the terminology: net asset value, or NAV
When an ETF issuer talks about “NAV” they are referring to the Net Asset Value of the fund. The NAV represents the per share or unit price of the fund. This is usually calculated each business day by the administrator of the ETF. This is very similar to what you see for mutual funds.
Bid and offer
The bid price is the price that someone is willing to pay for an ETF and the offer is the price at which they are willing to sell. Therefore, if you want to buy the ETF you will pay the offer price, which is the price that someone is willing to sell to you – and vice versa.
ETFs don’t rely on two-way order flow to create a bid/offer spread. There are always market makers who make two-way prices electronically to ensure investors can always buys and sell when the market is open.
Hints and tips
- To try and achieve a lower spread (the difference between the bid/offer), try to trade the ETF when the market the majority of assets in the ETF is open. For example, if you buy an ETF that holds US equities it is usually better to wait until the US market is open.
- Try to avoid periods of volatility in the markets where prices can move quickly and unexpectantly. This can be around times such as when economic data is announced or a major geo-political event.
- Try to avoid trading when the market first opens. There is often more volatility at this time and so it would be advisable to wait for 15 minutes where possible.
- Of course, like share trading, the value of ETFs can go down as well as up and your capital is at risk. You may not get back the amount you fully invested.
The risks and rewards of ETF trading
All investors hope that their investments quickly become profitable but there are some key risks you should consider:
- ETF prices go down as well as up
- Your capital is at risk and you may not get back the amount you originally invested
- Exchange rate fluctuations can have a negative or positive effect on returns