Do Not, I repeat, Do Not buy or sell ETFs at the open. Using a “market at the open” order type is setting yourself up to get a terrible price when buying or selling an ETF. That’s an unnecessary risk that is avoided by simply not trading at the open.
The price that you can buy or sell an ETF is determined by the Bid (the price at which you can typically sell) and the Ask (the price at which you can typically buy). These prices are set by market makers and should track the value of the underlying securities as a whole. Typically, the true price, or the NAV, of the fund is located somewhere in between the Bid and Ask. The spread on either side is where the market makers earn their profit. Here is a simple example – assume the ABC ETF is worth 25.00. The Bid is 24.97 and the Ask is 25.03. The 3 cent spread on either side is potential profit for the market maker.
Here’s the point to pay attention to: A market makers ability to set the Bid and Ask is dependent on their ability to determine the true price, NAV, of the fund. The underlying basket (the stocks, bonds, or other securities in the ETF itself) is what makes their job easy or difficult. There is risk in market making and they want to avoid any situation where they have bad data and pricing is off.
Think about this…when data is incomplete, the market maker reduces their risk by widening spread. A wider spread is protection for the market maker. If they can’t determine true NAV confidently, spreads will widen. When the market first opens, this is what typically happens. It takes a few minutes for all securities to begin trading and ETF spreads are wider than they would be once all securities have opened and are actively trading. It takes all of 2 to 5 minutes for spreads to tighten up for most ETFs. Don’t pay the price for being the one trade that’s placed at the open…
When it comes to spread, the best thing to do is to get a good idea of the size of the spread at which the ETF you want to buy or sell typically trades around. Do not buy or sell at anytime the spread is wider than average. Give wider than average spreads a few minutes to tighten up and if spreads don’t tighten up…call the issuer of the fund itself. I can assure you, issuers are accessible. Nobody cares more about how the fund is trading, let them know!
As with most aspects of ETF mechanics, the underlying basket of securities is important. Deep liquidity in the underlying is attractive for many reasons, including the size of the spread.
A wider than average spread is an added cost to potential investors, but a cost that can easily be avoided. Let the market open up so all securities are providing data for spreads to run tight and costs to you as an investor to decrease. In summary – DO NOT TRADE ETFs AT THE OPEN!