Understanding ETF trading volume and liquidity (2024)

FAQs

Understanding ETF trading volume and liquidity? ›

The primary factors that influence an ETF's liquidity are its composition and the trading volume of the securities that make it up. The secondary factors that influence an ETF's liquidity include its trading volume and the investment environment. Low-volume ETFs do not necessarily have low liquidity.

Volume And Market Impact

The higher the volume, the better. For example, if MSFT trades, on average, 10 million shares per day, it will be easier to trade than something that trades 100 shares per day.

ETFs offer three levels of liquidity—on-screen liquidity, broker-assisted liquidity and specialist-accessed liquidity.

Low trading volume doesn't mean low liquidity

Facing a choice between two ETFs with similar liquidity, investors should then look to other factors such as product quality, level of service from each provider and management fees to make a decision. To learn more about ETF investing visit our ETF learning centre.

But one of the most important ETF features—their liquidity—is also one of the most widely misunderstood. Liquidity refers to the ability to buy or sell a security quickly, easily and at a reasonable transaction cost.

Secondary market liquidity is determined primarily by the volume of ETF shares traded. To assess secondary market liquidity, follow an ETF at different times of day, over various time periods, and note how it's affected by market environments.

An uptrend paired with increasing and/or above average volume implies investor enthusiasm for that stock or asset is strong, which could lead to more buying and even higher prices.

ETFs have differing liquidity profiles for many reasons. Investing in an ETF with relatively low liquidity may cost you in terms of a wider bid-ask spread, reduced opportunity to trade profitably, and—in extreme cases—an inability to withdraw funds in certain situations like a big market crash.

A three-fund portfolio is a portfolio which uses only basic asset classes — usually a domestic stock "total market" index fund, an international stock "total market" index fund and a bond "total market" index fund.

How do you know if an ETF is doing well? ›

Since the job of most ETFs is to track an index, we can assess an ETF's efficiency by weighing the fee rate the fund charges against how well it “tracks”—or replicates the performance of—its index. ETFs that charge low fees and track their indexes tightly are highly efficient and do their job well.

Less Diversification

For some sectors or foreign stocks, ETF investors might be limited to large-cap stocks due to a narrow group of equities in the market index. A lack of exposure to mid- and small-cap companies could leave potential growth opportunities out of the reach of certain ETF investors.

ETFs make a great pick for many investors who are starting out as well as for those who simply don't want to do all the legwork required to own individual stocks. Though it's possible to find the big winners among individual stocks, you have strong odds of doing well consistently with ETFs.

You expose your portfolio to much higher risk with sector ETFs, so you should use them sparingly, but investing 5% to 10% of your total portfolio assets may be appropriate. If you want to be highly conservative, don't use these at all.

Stocks with thicker liquidity tend to have less volatility due to the availability of shares to meet the demand from both buyers and sellers. Thicker liquidity stocks are easier to enter and exit economically. Beginning traders should always start with the thick liquidity stocks.

Generally speaking, creditors and investors will look for an accounting liquidity ratio of around 2 or 3. A higher liquidity ratio means that your business has a more significant margin of safety with regard to your ability to pay off debt obligations.

Level of Assets: An ETF should have a minimum level of assets, with a common threshold being at least $10 million. An ETF with assets below this threshold is likely to have a limited degree of investor interest, which translates into poor liquidity and wide spreads.

To reduce such risk, it's best to stick with stocks that have a minimum dollar volume of $20 million to $25 million. In fact, the more, the better. Institutions tend to get more involved in a stock with daily dollar volume in the hundreds of millions or more.

For example, a typical balanced ETF might invest in a target allocation of roughly 60% stocks and 40% bonds. But asset allocation ETFs may take on a more focused objective and aim to cater to specific risk profiles, such as conservative, moderate or aggressive.

The ratio covers 50 days of trading. It divides the total volume on up days by total volume on down days to get the ratio. Look for stocks with ratios above 1.0. A ratio above 1.0 points to heavier demand, or more buying, while a ratio below 1.0 suggests more selling.