A how-to explanation on trading ETFs is something that we continue to get asked for from investors. What are the considerations when trading ETFs on the exchange?
ETF Mechanics
We need to understand how ETFs work on the exchange before getting into how to trade, as that will make the advice easier to understand. ETFs are priced based on the prices of their underlying portfolios and move over the course of the day with those underlying price movements.
ETFs have market makers that continuously post bid and ask quotes over the trading day. If the market maker buys or sells the ETF, they replenish their quotes. The spread on the ETF between the bid and the ask price, will reflect the spread on the underlying portfolio, plus any additional costs from the market makers. In addition, individual traders will post bid and ask quotes that may be inside the market maker’s quotes as they look for trade execution.
So unlike buying a stock, which has a limited number of shares available to buy or sell at progressively wider prices, an ETF is backed by the replenished quotes from the market maker.
As ETFs are open-ended vehicles, meaning that the market makers can request additional ETF shares or redeem ETF shares based on market demand, the price of the ETF should generally reflect those underlying prices, and not have significant rich or cheap prices compared to the underlying portfolio.
It is important to realize that the ETF then reflects the liquidity of the underlying portfolio, due to the share creation process. As an example, a new Canadian ETF based on the S&P 500 Index would still have access to the massive liquidity of that index, even if the ETF itself hasn’t traded many shares.
ETF Trading
LongPoint ETFs offers Canadian domiciled ETFs traded in Canadian dollars on the TSX including leveraged and inverse ETFs under Savvy (2X) and Mega (3X) branding.
The ETFs are highly speculative and use a significant amount of leverage which magnifies gains and losses. The ETFs are intended for use in daily or short-term trading strategies by very knowledgeable, sophisticated investors. For example, you could lose your entire investment in one day if the underlying index of the ETF experiences a single-day price movement that is greater than 33% for the Mega ETFs and 50% for the Savvy ETFs. In addition, if you hold the ETFs for more than one day, your return could vary considerably from the ETF's daily target return. The negative effect of compounding on returns is more pronounced when combined with leverage and daily rebalancing in volatile markets. The ETFs are not suitable for investors who do not intend to actively monitor and manage their investments.
Commissions, management fees, and expenses all may be associated with investment funds. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. LongPoint funds are managed by LongPoint ETFs and are available across Canada through registered dealers.
This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation. Investors should consult a financial and/or tax advisor for financial and/or tax information applicable to their specific situation.