[This article appears in our February 2020 edition of ETF Report.]
Trading an ETF isn’t necessarily difficult—it’s pretty much the same as trading a single stock—but if you’re trading in size, you often don’t want to go about it alone. Best trading execution means working with the best players, and that requires some due diligence.
At a very high level, here’s the challenge for working big trades, summarized by an ETF trader: “You can trade an ETF as an agent on exchange; you can route your order to someone else; you can trade on algorithm [high-frequency trading firms]; or you can go over the counter and ask for a two-sided trade through a market maker—not to indicate what side you’re on, but to put people in competition for you. There’s a host of different ways to trade.”
When you’re trading an ETF, there’s no shortage of things to consider. From getting the right order type—market order, limit order, stop loss order, etc.—to getting the best price, to understanding fair value, to navigating liquidity on screen and in the underlying, it all matters. (Since ETFs are baskets of securities—be they equities, bonds, derivatives, other ETFs or a mix of all of those—underlying liquidity can play a big role in trading execution just as much as average daily volume.)
Where to begin?
Know What You Need To Know
If you’re new to trading large blocks, the first thing you’ll want to do is talk to folks. Guidance can be critical.
As an advisor, chances are that guidance will come from your custodian—the likes of Schwab, Fidelity, TD Ameritrade and others—or from your affiliated wirehouse, such as Merrill Lynch, Morgan Stanley or Wells Fargo. These firms have expert trading desks capable of handling ETF order flow and model portfolios, and can help you figure out what works in your best interest: everything from what time of day, to what type of order, to where to make your trade.
In most cases, the process goes something like this: You call your broker/custodian and tell them what ETF you’d like to trade. They punch the information into a quote screen, check out the volume traded on the day—as well as bids and offers available from various dealers—and tell you what they see.
“For the majority of ETFs, you’re going to see several hundred shares at various price levels every day,” Paul Weisbruch, head of ETF sales and trading for New York-based GTS – Mischler, said. “It’s very efficient. You could put a fair amount of money to work without high-level assistance from anyone, quite frankly, because there’s plenty of screen liquidity.”
With or without the help of a custodian, trades of highly liquid ETFs can be a one-stop process. You can either trade on your own, or you can tell your affiliated wirehouse what to buy, and they’ll get you the best price available through an electronic order in 90 seconds or less. What’s more, in most cases today, ETF trading now happens commission free in these platforms. Simple and cheap.
But what if you’re not a Schwab or Fidelity client, or you simply need more help on a complex trade? That’s where an ETF issuer’s capital markets desk can come into play.
Every issuer has professionals standing by at their capital markets desk to talk to you about the intricacies of trading their products. They can tell you how their products compare with others in the marketplace, how they trade throughout the day and how liquid—or not—their underlying assets are. They can’t make the trade for you, but they can often provide real insight into when to trade, how to trade and even with whom.
But ETF trading isn’t always this easy.
Things can get more complicated if you’re looking to do a bigger trade that requires access to capital and liquidity, or if you’re trying to trade an ETF whose underlying index doesn’t trade during U.S. market hours; or if a fund has a very illiquid basket of assets.
For example, say you want to buy 50,000 shares of an ETF that trades only about 30,000 a day. You called your broker, and the numbers aren’t on your side because the volumes visible on screen aren’t anywhere near that large.
“An issue can arise if the order size exhausts what you see on the screen,” Weisbruch said. “It happens a lot with new ETFs. That doesn’t mean you can’t buy 50,000 shares; it just means the technique you’re using is going to be very important.”