How to trade ETFs

Trading ETFs or looking to start? Before diving in head first, here are a few tips that can make your experience easier and potentially more profitable.

Not sure what an ETF is, or need a refresher? Check out this article.

If you’re looking to get started trading ETFs, it’s important to understand your risk profile, time horizons and end goal for investing. Once you have a clear picture of this and have determined if ETF trading is right for you, then these five steps could get you started.

1) When is the best time to invest in ETFs? Check the NAV

Just like managed funds, ETFs have a Net Asset Value (NAV). This represents the value of the underlying assets and can be used to estimate the ‘fair value’ of an ETF.  Some investors use the NAV to determine the point at which they buy into an ETF, sometimes choosing to place an order to buy based on when the asset reaches or dips below its fair value or NAV. Most ETF providers update the NAV in real-time and depending on the broker you use, it may also be marked as the iNAV (indicative Net Value Asset).

2) Get familiar with the different fees for trading ETFs

Although, ETFs tend to have smaller fees than other investment options, such as managed funds, it’s still important to be across the different costs involved. Here’s a breakdown of the costs you are likely to incur:

• Management fee:

This fee, charged by the fund issuers, usually includes custodian, accounting and audit fees. For index-tracking ETFs, this fee will include index licence fees, and for actively managed ETFs it will also include an investment management fee.

• Brokerage fee:

A fee charged by the broker each time you make a trade. This fee will vary between brokers.

• Buy/Sell spread:

A hidden cost that not all investors are aware of is the buy/sell spread, also known as bid/ask spread. The spread is the difference between what a seller is asking for a stock or security and what a buyer is willing to pay and is generally calculated off the highest bid offer.

For example, take an ETF currently selling at $2.50 a share, which is the lowest price anyone is prepared to sell at. The buy price in this instance is $2.45 and represents the most anyone is willing to buy at. Therefore, the buy/sell spread is 5 cents or 2%.

The smaller the spread the less you have to pay. During the course of a normal trading day there can be several buy/sell spread prices. Spreads can be an indication of liquidity and supply and demand; generally popular stocks will have a lower spread and less-traded stocks will have a wider spread.

When assessing the fees of ETFs, a good point of comparison is the ‘all in cost.’ This figure takes into account the management fee, the buy/sell spread and any commission charged to trade the ETF.

Compare ETFs

3) Consider market volatility and news

Market volatility can cause the prices of an ETF’s underlying securities to move sharply, which can, in turn, cause the shares of ETFs to have wider buy/sell spreads. To potentially avoid volatile periods investors can keep up-to-date with market news, as ETF prices generally swing in response to the release of economic announcements and earnings reports from companies.

4) Use limit orders

Using limit orders over market orders can be a good way to trade closer to the NAV of an ETF. Limit orders allow investors to determine the price they are willing to buy and sell shares at. Placing a limit order can be particularly beneficial during times of volatility when trading prices tend to be further away from the NAV. The downside of using limit orders is that unlike placing a market order, your trade is not often executed immediately.

5) Trade at the right times

If you have to use a market order, it’s generally better to stay clear of the first and last 20 minutes of the trading day. The difference or spread in an ETF’s intraday price and the fund’s NAV is often the greatest at the market’s open and close. For example, towards the 4pm close, market makers begin to balance their books which can trigger wider spreads and increase an ETF’s volatility. Likewise, at the open, which is 10am in Australia, these price differences may persist until the market settles down.

Risks involved with ETFs

ETFs also have a number of risks to be aware of. These include market risk, liquidity risk and currency risk (particularly if you’ve invested in an international or global ETF). Check out this article on common investment risks to learn more. ETFs do not suit every investor, so before investing be sure to read the PDS, and if ever in doubt seek the help of a professional financial adviser.

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