3 tips for trading ETFs

What is an ETF?

An Exchange Traded Fund (ETF) invests in other investments like shares or bonds. They offer access to a diversified basket of investments for usually a much lower cost than purchasing them individually.

Most ETFs track an index – a collection of shares or bonds which represent a certain sector or region. For example, the FTSE 100 index is a list of the largest 100 companies in the UK.

When you buy an ETF, you're buying a slice of the ETF's underlying holdings.

How do ETFs work?

ETFs work in a similar fashion to index mutual funds.

Index mutual funds and ETFs are both passive investments that offer investors exposure to markets around the world by tracking an underlying index. However, there are differences between the two.

Mutual funds value and trade only once a day, usually at midday, so investors won't know exactly what price they're buying or selling at until after the trade's taken place.

ETFs on the other hand are traded on a stock exchange, like shares. They also track an underlying index, but the prices of ETFs fluctuate through the trading day. The ability to trade ETFs throughout the day adds greater flexibility, however timing the market is a tricky, if not impossible, exercise.

Tracker funds often invest in every stock which makes up the index it's trying to replicate – known as full replication.

Some funds won't invest in every stock, known as partial replication. This could be because some companies are too small for example, or are about to drop out of the index. Either way, buying and selling companies involves costs which eat away at performance. To try to keep performance as close to the index as possible, tracker funds can use techniques like reinvesting dividends at an appropriate time to keep costs to a minimum.

Learn more about ETFs and other Exchange Traded Products

3 tips for trading ETFs

ETFs can be a great way to invest, but there's a risk investors could be caught out if they aren't aware of some simple tips when trading.

We look at three main ones below.

This article isn't personal advice. If you're not sure if an investment is right for you, seek financial advice. All investments can fall, as well as rise in value so you could get back less than you invest.

1. At any given time, there are two prices for any ETF: the price at which someone is willing to buy (the "bid") and the price at which someone is willing to sell (the "ask"). The difference between these two prices is called the "bid/ask spread."
   To try and achieve a lower spread, you could trade the ETF when the market for the majority of the underlying securities is open. For example, if you want to buy an ETF which holds US shares, it's usually better to wait until the US market is open. This is because markets are moving in real time so the underlying shares should be more accurately priced.
2. Bid-ask spreads can also increase during periods of volatility, so it's usually best to avoid trading ETFs during the first and last 15 minutes of the trading day. You should also keep an eye out for when economic data is announced, or major political events are taking place, and try to avoid trading around these times.
3. Be aware of different types of orders. Different orders can impact an investor's trading outcome. In ETF trading, two orders are particularly important – market orders and limit orders.

• A market order is an order to buy or sell a stock at the market's current best available price. It typically makes sure the trade will be placed, but doesn't guarantee a specified price. This type of order is used where investors are looking to carry out a trade straightaway.
• A limit order is where you set a specified price to buy or sell a stock. For buy limit orders, the order will be executed only at the limit price or a lower one. While sell limit orders will be executed only at the limit price or a higher one. This type of order could be beneficial for investors waiting to buy a stock at a lower price, or to sell a stock at a higher price, but perhaps don't have the time to constantly monitor the stock's price.

You can learn more about the benefits of investing in ETFs via our research page.

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