Since ETFs trade like stocks, large Bid-Ask trading spreads can eat into your potential profits. As a general rule, this does not appear to be a problem with ETFs that are heavily traded. To demonstrate, at the time of this writing, I checked out the spreads for 2 ETFs that I don’t have any positions in at the moment.
Let’s take a look at EFA, one of the most heavily traded ETFs with a daily average volume of some 7.5 million shares. The current Bid-Ask spread is 76.66-76.67, which is a difference of 1 penny.
Contrast that with DGG, and an average volume of just over 7,000 shares, and you will see a Bid-Ask spread of 32.13-32.19, which is a difference of 6 pennies. If you want to look at it as a percentage of the current price, the difference becomes even more glaring.
Again, this is only one aspect of selecting an ETF, but a very crucial one. More importantly, low volume will also make it more difficult to get out when your sell stop point gets triggered and the exit doors become more crowded.
Just because new ETFs are being offered and cover a unique area does not mean that you should invest blindly. My rule is to watch newcomers for about a year or so to see how pricing and volume develops.
Comments 2
When considering average daily volume for an ETF,what would be your suggestion for a minimum volume amount? Would 250,000 be a good minimum or would you prefer a million or more before you would invest in it. Richard
Richard,
To be clear, that depends on how much you are planning on investing in an ETF. If I want to purchase $2 million worth, I want to see at least 3 times of that in average daily volume. I don’t want to be the big dog on the block.
If you as an individual are planning on investing a small amount, you can apply a lesser standard.
Ulli…