Most Popular ArticlesSeptember 15, 2009
One portfolio manager bought 71 percent of the entire day’s trading volume of RWJ on May 1, 2009 without moving the price of the ETF away from the IV. Going into May 1, there were only 800,000 shares of RWJ outstanding, and this portfolio manager purchased approximately 15 percent of the shares outstanding without moving the ETF’s price. This is virtually impossible in the world of closed-end funds and illustrates why it is vitally important to draw a line between closed end funds and ETFs.
Why was this possible and why does the equity index ETF space work this way? ETFs like RWL, RWK, and RWJ are open-ended index funds based on highly liquid and well-benchmarked S&P indexes that can create an unlimited number of shares as new buyers in the marketplace demand them. Think of equity index ETFs like a clown car that, no matter how many passengers step into it, the car never has a capacity problem, and never shuts the door on any one given passenger who wants to get inside, take a seat, and get comfortable. Yet the car doesn’t need to “make room” for all of the passengers as they get into the car since the car is an open-end index fund with the ability to create or redeem an unlimited number of shares.
Unlike an individual stock or a closed-end fund, where there indeed be liquidity problems, when everyone needs to get out of the car, or sell, the ETF will still trade near the value of the underlying index due to these same characteristics. Understanding how ETFs trade, and the best way to receive proper execution whether you are managing the orders yourself of working through a trading desk is of the utmost importance and will translate to real dollars added to your bottom line.
The Golden Rules of ETF investing
I will leave you with a few Golden Rules:
- Do not evaluate the quality of an ETF or its suitability for a client based on volume alone. Metrics such as the percentage of volume that represents new buyers and sellers need to be taken into consideration. Volume alone is largely noise.
- Ask where the ETF is invested. Is it a straight forward, long-only equity index ETF? Or is it something more esoteric that relies on futures, options or leverage of some sort? These major differences are much more important than questioning volume.
- Understand IV (NAV), how it relates to the real time pricing in terms of an ETF’s bid/ask in the open market, and how to use IV to one’s advantage in the pursuit of proper trade order execution.
- Utilize trading desks for larger block sized orders and always use limit or “marketable limit” orders to provide protection on buy and sell orders.
- Buyers, sellers and trading volume do not dictate price fluctuations for equity index ETFs, but rather the up and down ticks of the securities within the index that the ETF tracks.
Paul Weisbruch is the Director of Institutional ETF Sales at RevenueShares™ Investor Services. Paul has experience as an institutional ETF trader, both on the floor of the Philadelphia Stock Exchange (PHLX) and on an upstairs OTC ETF trading desk He was actively involved in trading and making markets for institutional portfolio managers in products such as the DIAMONDS Trust (DIA) and SPDR S&P 500 (SPY) over the past decade when misinformation regarding ETFs was rampant and the education on trading ETFs was even more lacking than it is today.
You can reach him at
or 877-738-8870 x 202 to discuss ETFs and how to effectively trade them.
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