ETF Tradability: A Primer

August 26, 2014

Understanding how to trade ETFs means understanding a number of crucial metrics.

The “T” in ETF often throws investors. After all, it’s the exchange-traded part that creates situations like the wacky premium Paul Britt noticed in MLP ETNs last week. It’s what everyone worried about in the “flash crash.” And if you’re used to investing in mutual funds, not stocks, it’s the scary new part of ETFs.

But it doesn’t have to be. That’s really the reason we have an entire tab devoted to Tradability in ETF Analytics—to demystify what’s really a pretty simple transaction.

The first thing you see when you go to any ETF (I’m using the iShares MSCI Emerging Markets ETF (EEM | B-98) here as the example) is the score:


That score gives you a rough guide for how well the ETF trades relative to the entire universe of ETFs. It rolls up all of our trading inputs, from simple on-screen volumes to much-more-finicky bits about how the underlying securities in the portfolio trade. To see how that “86” for EEM compares with the segment, you can look to the overall scoring graphic on every EEM page:


The orange line is where the average ETF in the segment—in this case, Total Market Emerging Markets Equity ETFs—trades. You can see that EEM does better than average not just in Tradability but in its Efficiency and Fit as well. That shouldn’t come as too much of a surprise, as it’s one of the largest and most successful ETFs on the market.

But what’s actually going on under the hood regarding that “86” rating in tradability?

Underlying Liquidity

Broadly speaking, we look at two things in our tradability methodology: measurements of real-world on-screen liquidity; and measurements of underlying liquidity.

Put another way, we look at how the ETF itself trades, and how what the ETF owns trades. The reason is simple: If you’re going into the market to buy a relatively small number of shares, all you’re really concerned with is how the ETF itself is trading.

If, however, you’re buying a very large number of shares—at least, relative to how much of the ETF trades on a normal day)—your experience is likely to be dictated by how well the securities the ETF holds trade as much as how well the ETF trades. That’s why we look at both.

On the right-hand side of the page, we break these measurements down in a number of ways:


This first block purely shows you how the ETF trades. It seems obvious, but there are a few nuances here. The first is that we look at median as well as average trading days. This matters because it’s not uncommon to find ETFs that trade very little for weeks at a time, and then trade 100,000 shares in one trade.


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