You Picked the Right ETF. Did You Trade It the Right Way?

ETF Investors Focus on What to Buy. But What About How to Buy?

ETF investors spend an enormous amount of time deciding what to buy.

In my experience, they don't spend nearly enough time deciding how to buy it.

Over the past two decades, the ETF industry has done an outstanding job educating investors about how ETFs work.

Today, investors understand concepts like creation and redemption, premiums and discounts, and that an ETF's liquidity extends well beyond its average daily trading volume.

But I believe one area still deserves much more attention:

ETF execution.

A Trade I'll Never Forget

One trade has stayed with me throughout my career.

I watched a relatively modest ETF order execute several percentage points above where the ETF had been trading only moments earlier. Nothing malfunctioned. The market worked exactly as instructed. The order simply swept through the available displayed liquidity.

Around the same time, another investor traded a position roughly twenty times larger in that very same ETF.

Instead of relying solely on the displayed market, the order was worked through an ETF block trading desk.

The execution was completed approximately one penny better than the displayed offer.

The larger order received the better execution.

The difference wasn't the ETF.

It wasn't the market maker.

It was the execution strategy.

The Next Frontier of ETF Education

Unfortunately, I've seen variations of this story play out many times throughout my career.

Investors often spend days or weeks researching which ETF to buy, yet many spend only a few seconds deciding how to execute the trade.

In my opinion, that's the next frontier of ETF education.

Why One Size Doesn't Fit All

One of the biggest mistakes I continue to see is investors applying the same execution strategy to every ETF they trade.

Take VWAP algorithms as an example.

VWAP can be an effective execution strategy for a heavily traded ETF with consistent trading volume throughout the day.

But apply that same strategy to a newly launched ETF or a specialized ETF where your order represents a meaningful percentage of the day's trading activity, and the results can be very different. Rather than seeking liquidity, the algorithm may simply spend the day lifting offers.

The execution strategy didn't fail.

It simply wasn't the right strategy for that ETF.

The Problem With Market Orders

The same applies to market orders.

Throughout nearly thirty years of trading ETFs, I don't believe I ever entered a market order.

That wasn't by accident.

In my opinion, investors should avoid using market orders when trading ETFs.

Over the years, I've seen far too many market orders produce executions that were dramatically worse than investors expected.

A market order guarantees execution.

It does not guarantee price.

Once the displayed offer is exhausted, the order simply continues executing against the next available offers until it is complete. In today's electronic markets, that can become very expensive very quickly.

Timing Matters More Than You Think

Timing is equally important.

The exact same ETF can trade very differently depending on when an order is entered.

Major economic announcements, FOMC decisions, overseas market closings, ETF creation and redemption cut-off times, and other scheduled market events all affect how market makers manage risk.

During those periods, spreads often widen temporarily while new information is incorporated into prices.

An order entered a few minutes earlier, or a few minutes later, may produce a meaningfully different execution.

Displayed Liquidity vs. Available Liquidity

Another concept that deserves more attention is the difference between displayed liquidity and available liquidity.

One of the biggest misconceptions in ETF trading is assuming the liquidity displayed on the screen represents all of the liquidity available.

It doesn't.

Today's Lead Market Makers manage hundreds, and often thousands, of ETFs simultaneously. As a result, the displayed market often represents only a small fraction of the liquidity they are actually willing to provide. Rather than displaying their full trading interest, liquidity providers manage risk while making additional liquidity available through processes such as RFQs and block trading.

That doesn't mean the liquidity isn't there.

It simply means investors often need to ask for it.

The Value of RFQs and Block Trading

For larger trades, and often for newer or more specialized ETFs, working through an ETF block trading desk or utilizing a Request for Quote (RFQ) process allows multiple liquidity providers to compete for the order. Frequently, that produces significantly better executions than simply trading against the displayed market.

How ETF Trading Has Evolved

Early in my career, I served as an ETF Specialist on the American Stock Exchange, a role similar to today's Lead Market Maker.

Back then, there was considerably more human judgment involved in handling ETF orders. Specialists could pair buyers and sellers, improve executions, or work an order to achieve a better outcome.

Today's markets are faster, more electronic, and vastly more sophisticated.

That's progress.

But it has also changed where the responsibility lies.

Who Is Responsible for Best Execution?

Market makers are responsible for providing liquidity and managing risk.

They are not responsible for choosing the best execution strategy for each investor.

That responsibility increasingly belongs to the investor, advisor, or trader entering the order.

Final Thoughts: Execution Deserves Equal Attention

The ETF industry has made tremendous progress educating investors about ETF selection.

I believe the next step is educating investors about ETF execution.

Good ETF execution doesn't happen by accident. It happens through thoughtful planning before the order is ever entered.

 Disclaimer

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.