With SMI increasingly using exchange-traded funds (ETFs) in our strategies, we receive a decent number of questions about how to buy and sell such funds. They’re not quite as easy as working with traditional mutual funds where, as long as you’re investing the required minimum amount, you can buy in the exact dollar amount you want. At most brokers, ETFs only trade in full share amounts, which means you have to do the math to figure out how much you can buy, dividing the dollar amount you’d like to invest by the ETF’s share price. (At Fidelity, that’s no longer necessary because ETFs now trade in fractional shares).
For those who’ve gotten acclimated to trading ETFs, another idea to consider is that some times of the day may be better for making trades than others. Perhaps you’ve heard that it’s best to avoid trading ETFs for 30 minutes after the market opens and 30 minutes before the market closes, when volatility may be higher and bid-ask spreads wider, meaning you may end up paying more for a fund than necessary.
Vanguard, which has long considered such rules to be “best practices for ETF trading,” recently took a closer look and found them to be only half true. “The data seems to suggest that ETF investors have reason to avoid trading early in the morning, but the data do not show any reason to avoid trading at the close,” according to Jim Rowley, Vanguard’s head of investor research.
The company analyzed nearly 170,000 bid-ask spreads of 166 U.S. fixed income ETFs during 78 intraday intervals over the course of more than three years. “We found that spreads tend to begin each day at a high point, fall throughout the morning, and then remain generally flat through the end of the day,” Rowley said. And that held true during times of calm and times of high volatility, such as the first quarter of 2020.
Vanguard’s research looked at spreads in five-minute intervals throughout the day, finding the widest spreads in the first five minutes of trading, but also notably elevated spreads until late morning. The company said that volume tended to increase toward the end of the day, but bid-ask spreads did not.
While Vanguard’s research focused on fixed income funds, it covered a wide spectrum of such funds, from government bonds to high-yield “junk” bonds, and the company seemed to suggest that its findings apply to ETFs generally.
What’s SMI’s take on this “timing” research? We’ve always encouraged our members to make trades on a timely basis. That means when a strategy update comes out that requires a trade, you should make that trade within a day or two of the announcement. How much might it improve your returns to avoid making trades soon after the market opens on a particular day is difficult to know. But the research seems compelling enough to suggest that not trading during the first portion of the morning is a good idea. And as SMI has long suggested, if you’re buying or selling an ETF whose spread is more than a few pennies, using a limit order may be worthwhile.