ETF Liquidity – Four Rules to Consider

download pdf


Liquidity, transparency, real-time trading, and relatively low management fees are the reason why ETFs are becoming more and more popular as investment vehicles. Still, there are key characteristics that investors should better understand, in order to trade them properly and seek the best order execution.

Of course the largest ETF names are the simplest to trade due to their tight spreads (difference between the bid and ask*). Tight spreads signal liquidity from the large volume of shares trading throughout the day. Traders feel comfortable that they can buy and sell, or sell short, these ETFs.

But what about ETFs that don’t have millions of shares trading every day? Here are four ETF trading tips you may want to consider:

Rule #1: ETF Volume, alone, may be a poor measure of liquidity.

ETFs are just a “wrapper” for the underlying basket of securities that it’s holding. So the liquidity of an ETF is based more on the volume of those underlying securities, than the volume of the ETF itself. If the underlying securities you are accessing through the ETF are liquid, you should have confidence you will be able to easily enter and exit the position in the ETF.

In fact, the volume you see on your trading platform’s screen may NOT represent the actual liquidity of the ETF. The volume data, along with the bid/ask spreads will depend on your trading platform’s level of data access. If you have any concerns on whether or not there’s enough liquidity to get a fair price, call your broker or trading desk.

Trading large blocks: If you’re considering a trade of 25,000 shares or more, contact your broker, or trading desk. Should your trading desk need assistance, Direxion can help facilitate your order through an Authorized Participant (AP). APs are large institutional market makers that use their ability to exchange large blocks of the ETF (creation units) with their underlying securities to help you enter into, or exit out of, sizable positions without affecting the ETF share price, regardless of the market volume of the ETF.  


Rule #2: Always Use Limit Orders.

Market orders leave you vulnerable, and at the mercy of the seller. Your order could get filled at various unfavorable prices, depending on what’s happening on the other side of the trade. Place a buy or sell order within several cents of the bid or ask price, to get the best execution.

Hypothetical example of a market order (see graphic below)

If a trader enters a market order to buy 2,000 shares, the trade will execute at the best offer level. In this example, the best offer is 50 shares @ $20.02. If the number of shares at that price are exhausted, the order will move to the next best offer (200 shares @ $20.03). This process continues until your order is complete, which may be at a much higher price. For a market order to sell, the same process takes place down the bid side of the spread. A limit order will help you get the best order execution.

Hypothetical ETF: XYZ
Hypothetical Market Order: 2,000 Shares
For illustrative purposes only

In these two scenarios: The average price received on a market order to buy 2,000 shares is $20.11. The average price on the market order to sell is $19.89. Neither trade received the optimal execution.

Rule #3: Avoid trading at the open or the close.

Trading in the fi rst, or last, 30 minutes of the session is not a good idea in general. This rule goes for any security, but it’s especially true for ETFs. At the start of each trading session, big institutional traders, speculators, market makers, and authorized participants unwind their overnight positions or gain exposure to needed assets for the trading day. So, if you can, wait a half hour or so, and then start trading.

Rule #4: Know the iNAV.

Since ETFs trade throughout the day, you need to assess its current value as defi ned by the current value of the underlying securities. This can be done by monitoring the funds iNAV. The iNAV is a measure of the intraday net asset value (NAV) of the ETF. It’s updated every 15 seconds, and gives an updated measure of the intrinsic value of the underlying basket of securities.

You can get the iNAV for any domestic ETF by simply entering the ticker symbol, then a dash, then “IV” on your platform’s trading screen. So to find the iNAV of the Direxion NASDAQ-100 Equal Weighted Index Shares (QQQE), just type “QQQE-IV” (some platforms may use a period instead of a dash − “QQQE.IV”).

Note: International ETFs do not have iNAV quotes.

As you seek better outcomes for your ETF portfolio it’s important to arm yourself with the trading knowledge to ensure the best ETF order execution. Following these four rules may help you do just that.



*The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it.

The Fund is non-diversified and include risks associated with concentration risk that results from the Funds’ investments in a limited number of securities. The Fund may at times use derivatives such as futures contracts, forward contracts, options and swaps which could subject it to market risks that may cause price fluctuation over time. Derivatives may expose the funds to additional risks that it would not be subject to if it invested directly in the securities underlying those derivatives, such as counterparty risk.

Increased portfolio turnover may result in higher transaction costs and capital gains. For other risks including counterparty risk, tracking error risks and specific risks of exchange traded funds, please read the prospectus.