of ETF liquidity Since the first U.S. ETFs came to market in the 1990s, promoters extolled the idea of their intraday liquidity and pricing. “You can trade ETFs just like stocks!,” they cried.
The ABCs
of ETF liquidity Since the first U.S. ETFs came to market in the 1990s, promoters extolled the idea of their intraday liquidity and pricing. “You can trade ETFs just like stocks!,” they cried.
While generally true, many investors still struggle to effectively evaluate the liquidity
profile of an ETF. So, let’s bridge this knowledge gap.
The more popular ETFs become, the more important it is for investors to use the right
trading strategies—and knowing the right trading strategies is based on a robust understanding of ETF liquidity. That’s especially true of large trades, which can be complex and, if mishandled, create negative consequences for client portfolios.
When considering all the variables necessary in choosing the right ETF—liquidity being
one of them—it’s best to keep it simple: Does an ETF have the right amount of liquidity for my trading needs? The answer for a Vanguard ETF, most likely, is yes.
Liquidity is simply a measurement of how quickly and easily investors can enter or exit
a position in the market without impacting the price of a security—in this case an ETF.
Securities with less liquidity are usually more costly to trade because there are fewer
counterparties and could lead to greater market impact. Securities with more liquidity are easier and less costly to trade because they benefit from the efficiencies of higher trading volumes, which include greater pricing transparency and operational efficiency.
Unlike individual stocks, which are traded only on secondary markets, ETFs offer two
distinct layers of liquidity: in the secondary market where ETFs trade along with stocks, and in the primary market, where ETFs are created and redeemed by the ETF’s authorized participants.
Investors trading larger positions should effectively leverage both forms of ETF
liquidity, provided they employ the appropriate trading strategy. Rigorous trading hygiene starts with an evaluation of an ETF’s liquidity in the secondary market—but, if a trade is large enough, making well-mapped-out use of the primary market is essential. 1 1 Use of the primary market invariably involves contacting and working with capital markets professionals, such as those on the Vanguard ETF Capital Markets Desk.
Primary and secondary markets of an ETF
ETF ETF
Most-relevant ETF
liquidity metrics for each market
Where ETFs are created
and redeemed.
Where ETFs are traded, along with
individual stocks and bonds.
