Many Canadians have been won over by the advantages of investing in exchange-traded funds, including their low cost, transparency and potential to deliver broad portfolio diversification.
ETFs are also relatively easy to trade, making them ideal for both advisers and do-it-yourself investors.
“We’re believers in index investing,” says Dan Bortolotti, portfolio manager at PWL Capital in Toronto, whose firm only uses ETFs in its client accounts.
“The evidence is clear that ETFs give the best return for investors – the greatest possible diversification at the lowest possible cost.”
Still, some investors may be missing out on certain ETF trading strategies that can give them an advantage in their portfolios. Below are some best practices for buying and selling ETFs to help investors make the most of their returns.
Get reliable quotes
Most online brokerages now offer free real-time quotes, but some may offer only delayed quotes unless you pay an additional fee for better data, Mr. Bortolotti says. He recommends investors get access to what’s known as “Level 2” quotes if they can, which offers more market depth, including how many shares are currently offered for purchase and sale at specific prices, and which market participant is doing the buying and selling. Most brokerages offer access to Level 2 quotes, but at an additional cost.
Use limit orders
A limit order is a request to purchase or sell a security at a specified price or better. When buying, the order will only be executed only at the limit price or lower. For ETFs, Mr. Bortolotti recommends placing your order to buy at the ask price (or a penny above), and place your order to sell at the bid price (or a penny above.) “You’re not haggling for a better price, and you’re not setting yourself up to pay more (or accept less) than the current market price,” Mr. Bortolotti says. “You’re just protecting yourself against surprises.”
For most ETFs, a limit order placed at the offer price (when buying) or at the bid price (when selling) gives you the best chance for complete “fill,” or execution at the fairest price, even at very large sizes, says Daniel Straus, vice-president of ETFs and financial products research at National Bank Financial Inc.
Don’t fret about trading volume
Unlike with individual stocks, low volume does not necessarily mean less liquidity for ETFs. The investment companies that manage the ETFs ensure the funds' trade close to their net asset value. “With stocks, if there is low volume, there can be a large bid/ask spread and your order can move the market,” Mr. Bortolotti says. “With ETFs that is not the case. Ever. “That’s because ETFs are able to issue new units to accommodate new buying, he says, whereas stocks have a fixed number of shares outstanding on any given day.
Mr. Straus has found that an ETF that displays very low (or even zero) volume on the stock exchange may, in fact, be very liquid and able to absorb huge orders without making a dent in its price. However, he says high trading volume in an ETF can be a positive indicator of activity between the bid and ask.
Don’t trade on U.S. market holidays
Canadian-listed ETFs holding U.S. stocks still trade on days the Toronto Stock Exchange is open, even when American exchanges are closed, such as on Martin Luther King Jr. Day in January. However, it’s not always recommended, Mr. Bortolotti says. “You can trade on these days, but the quotes are likely not fresh,” he says. “Weird things can happen,” such as trades going through at inaccurate prices.
Don’t trade at the open (or close)
Pricing anomalies are more likely to occur right after the market opens or just before closing, Mr. Bortolotti says, which is why he recommends not trading within 10 or 15 minutes of the bell.
Investors also shouldn’t expect orders placed after hours to get filled as soon as the market opens, says Brooke Thackray, a research analyst at Horizons ETFs Management Canada Inc. Given the volatility in the underlying securities, the spread on ETFs can be larger in the first half-hour of trading, so it is best to avoid trading ETFs at that time, Mr. Thackray says.
Understand dividend dates
ETFs generally pay out dividends, in a similar manner to stocks. Just like stocks, ETF values will drop when they are trading “ex-dividend,” which is after the date of record for the dividend to be paid, but before the date that dividend is actually transmitted. It’s fine to trade during this period, so long as investors realize whether or not they will be receiving a dividend.
Be wary of stop-loss orders
A stop-loss order triggers a sale if your ETF falls to a specified price. This strategy makes sense for traders, but not for long-term investors, Mr. Bortolotti says. “It’s almost like a systematic way to panic-sell,” he says. Instead, Mr. Bortolotti believes investors should make conscious decisions to buy or sell at a given time and price, rather than use an automatic mechanism.