The media is calling last week’s freak 1,000 point plunge in the Dow Jones Industrial Average a “flash crash”. The crash was especially deadly for ETFs. Media reports indicate that as much as one fourth of ETFs suffered suspicious declines. More than two-thirds of the names on the list of canceled trades involve ETFs. ETFs trading on the TSX were not immune to the crash. For instance, the iShares Dow Jones Canada Select Dividend Index Fund (XDV) traded as low as $14.30 and recovered to close at $19.15.
Most of us are investors, not professional traders and we buy ETFs with the aim of holding them for the long-term. However, we have to recognize that, unlike mutual funds, ETFs depend on markets operating smoothly to keep prices in line with NAV and markets do occasionally go haywire.
Don’ts in Trading ETFs
- A Stop Loss Order is a sell order placed below the current market price. It becomes a market order if the stock reaches the stop loss price or trades below it. If you enter a stop loss order, your experience could turn out like this one reported in the Wall Street Journal. A financial advisor with $4.2 million in three widely-held ETFs had placed sell orders on them. They were cashed out at prices ranging from 10 cents to 12 cents leaving a grand total of $4,200 in the account. Don’t let it happen to you.
- A Market Order is an order to buy or sell a specified number of shares at the best available price. For liquid and widely-held ETFs, market orders are typically filled close to the market price. But in times of extreme volatility, a sell order even for the most liquid security might attract just stink bids. It may be best to avoid this risk altogether with a Limit Order.
Dos in Trading ETFs
- A Limit Order specifies the price at which you are willing to buy or sell a security. By entering a buy order at a penny or two higher than the ask price or a sell order at a penny or two less than the bid price and the bid-ask prices are close to NAV, an ETF investor can avoid being surprised by market action like the one last week.
- If you must, at least enter a Stop Loss Limit Order, which is exactly like a Stop Loss Order, except that it becomes a limit order if the stop loss is triggered.
