3 ETF Trading Tips You Are Missing

by on May 17, 2012

The growth of the ETF industry has led to major strides forward in democratizing the investment process, and ongoing evolution in the exchange-traded universe continues to bring forth previously hard-to-reach asset classes at the fingertips of mainstream investors. With innovation also comes complexity however, and ETFs are no different from other financial instruments in the sense that they are far from foolproof despite their numerous efficiencies  [see also Free Report: How  To Pick The Right ETF Every Time].

The ever-changing financial landscape demands that investors and traders alike stay on top of noteworthy developments in the industry as well as keeping up with ETF education, which is certainly an ongoing process. As such, below we outline three important ETF trading tips which are all too often overlooked:

Is The Market Open?File:Chicago Mercantile Exchange (G. Bush).jpg

This is a serious question that far too many investors forget to ask themselves before buying into a position. When trading ETFs that offer exposure to foreign equities, commodities, and currencies, it’s important to ask yourself whether the underlying market you wish to access is actually open for trading. Why? Because it costs more to trade when the ETF and the securities it is supposed to track aren’t trading at the same time. Timing your ETF trades while the market for the underlying securities is open may help to reduce pricing discrepancies; simply put, it pays off to trade when the market you wish to access is actually open [see also 5 Simple ETF Trading Tips].

Keep in mind that, European stocks traded on the Euronext are open for trading until 10:30AM (EST), while the London Stock Exchange is open until 11:20AM (EST), and stocks traded in Australia, China, and Japan do not overlap with Wall Street trading hours. For commodity traders, metals futures on the Comex Metals Exchange are traded from 8:20AM-1:30PM (EST) and grain futures at the Chicago Board of Trade are traded from 10:30AM to 2:15PM (EST) [see CME Group Trading Hours].

Trade Inside The Spread

When you look at an ETF quote, the “bid” and “ask” prices should jump out at you. The bid price that you see is the highest advertised price that you can get right now as a seller. Likewise, the ask price is the lowest advertised price that you can pay if you are looking to buy. Industry expert Ron Rowland writes,  “The key word here is “advertised.” Often you can buy for less than the ask, or sell for more than the bid”.  In other words, don’t be afraid to set your limit order at a price you feel comfortable paying, instead of jumping into the advertised price right away (and vice versa for selling).

For your next trade, consider placing your limit order somewhere inside the bid-ask spread; this way you may be able to cut trading expenses by getting a better deal on the price which you bought, or sold, at. If the bid/ask is $40.20/$40.40, try placing your buy limit order at $40.25 and see if you can get filled at a lower price than what’s being advertised [see also Five Important ETF Lessons In Pictures].

Watch Out For Distribution Dates

ETFs by natures are designed as tax efficient vehicles, although sometimes unforeseen tax distributions can have  material consequences. For example, leveraged and short ETFs can incur noteworthy short-term capital gains if the value of the underlying derivative contracts soars and there is a massive shareholder redemption; such a scenario would in turn force the fund manager to sell the positions and pass on the gains to remaining shareholders. As such, large tax liability events can certainly lead to volatile trading for certain ETFs [see also 25 Things Every Financial Advisor Should Know About ETFs].

The advice here is simple: stay alert. Be aware of upcoming tax distributions dates for ETFs you own; also, keep an eye out for large pending tax liabilities on funds you are looking to buy, because you might be able to get in at a better price after the distribution record date.

Follow me on Twitter @SBojinov

[For more ETF analysis, make sure to sign up for our free ETF newsletter or try a free seven day trial to ETFdb Pro]

Disclosure: No positions at time of writing.