How To Make Money Trading ETFs

| September 5, 2008 | 0 Comments

A few months ago I was sitting in yet another hotel ballroom.  It was another money management seminar.  The event was hosted by a California based financial advisor, he was doing his best song and dance. I love listening to these sales pitches . . . not for what they say, but for what they don’t say.

What they leave out is often the most important information – Don’t you think?

Anyway, the money manager droned on and on.  My mind started to wander as he touted his “amazing” ability to sidestep bear markets.  I’ve heard stories like this before.

I’ve got to be honest.  It really bothers me when a financial advisor claims the unique ability to get in at the bottom and out at the top. They’re either lying, or they’re lying.  Nobody’s that perfect.

If you ever meet someone claiming to be perfect get up and walk out . . . I’ve done it several times.

Amazingly, he did say something that makes sense.

Believe it or not, this money manager’s entire practice was focused on using ETFs.  They rarely touched stocks.  They avoided mutual funds.  All those other high priced investment vehicles were out the window.

I was starting to get impressed.

The focus on ETFs really caught my attention.  As I’m sure you’re well aware, I love ETFs.  I use them in my own personal retirement accounts.

They have a list of advantages that are longer than my arm.  I won’t bore you with all those details though.

Most investors don’t realize there’s little “tricks of the trade” that can help them make more money . . . even when investing in ETFs.

And who doesn’t like to make more money?

So here are a few insider secrets to trading ETFs.  I’m sure your broker never mentioned any of these to you.

First, watch the bid/ask spreads.

Every security traded on the markets has a bid/ask spread.  It’s simply the price difference between what a buyer pays and a seller receives. These few pennies are how many market makers and brokers make their money.  I know they already make a ton of money, but everyone has to pay this “toll.”  There’s no getting around it.

But, some of these spreads can get really big.  By limiting the size of the spread, you’ll put more money in your pocket.

Second, the bigger the ETF the smaller the spread.

Big ETFs can trade hundreds of thousands of shares a day.  These have really tight spreads.  For example the S&P 500 Index (SPY) currently trades at a penny spread.  That means right now it costs 122.94 to buy and 122.93 to sell.

Now a specialty ETF might have a much wider spread.  For example the HealthShares Cancer ETF (HHK) is a specialty ETF focused on companies that provide cancer research and drugs.  This ETF trades only a couple thousand shares a day.  Its spread is much, much bigger.  Right now the spread’s more than $0.60 per share! $32.70 bid, $33.30 ask.

How do we make money off this?

Simple.  If you’re rapidly trading ETFs focus on the biggest and most liquid.  Hold less liquid ETFs as longer term investments.  Don’t try to actively trade them.

Third, use limit orders.

Another way to reduce the impact of the bid/ask spread is to use limit orders.  This is a type of order where you provide a specific price.  It’s nice because you know exactly what price your order trades at.  But, your limit order may not be filled immediately.  It’s more likely it’ll sit in the queue for a while.  It could be held up for as little as 5 minutes or as long as all day.  There’s no guarantee your order will get filled.

The fourth and final secret is a simple one.

Don’t place your buy or sell orders at the market open.

Strange I know, but here’s why.

An ETF is made up of a basket of stocks.  The ETF will change prices as the basket of stocks change price.  The market typically sees an influx of buying and selling orders at the start of the day.  The market makers need to sort out opening prices for each of the stocks.

If you try to trade an ETF and some of the component companies haven’t started trading yet, the spread is going to be huge.  Market makers are building in extra padding in their bid/ask spread.  They don’t want a stock to open higher or lower than expected.

I know it sounds a bit complicated . . . believe me it’s a bit difficult to explain.  Just remember, as a rule, don’t trade any of your ETFs during the first 30 minutes of the market open.

There you have it.  A few simple insider secrets to trading ETFs.  Secrets your broker would never tell you.  These secrets should save you money every time you trade ETFs.

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Category: ETFs

About the Author ()

The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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