One of the first rules of buying and selling ETFs is to always use limit orders, never market orders. A limit order allows you to specify the maximum price you’re willing to pay, or the minimum you’re willing to accept. By setting this limit a couple of cents above the ask or below the bid you ensure you won’t be surprised by a sharp move in the markets or a pricing anomaly.
That message seems to be well understood, but a related issue has come up a few times with clients of our DIY Investor Service. We’ll be working with a client who has a nine-to-five job, and when it comes time to implement the portfolio he’ll ask whether we can make the trades in the evening, after the markets have closed. Wouldn’t the orders just be filled the next day after the opening bell, he’ll ask? They might, but you may not like the results.
Prices that go bump in the night
It’s quite common for companies and governments to make important announcements in the pre-market or after hours, which may causes price of securities to open sharply higher or lower than their previous closing price. When that happens, market orders could get filled at a price much higher or lower than you expected. And even though limit orders are safer, they may go unfilled if an ETF’s price opens well above or below its previous close.
International equity ETFs can be especially vulnerable, since their domestic markets are open when North American exchanges are not. When the opening bell rings in Toronto or New York, market makers need to update prices based on what happened during the night.
And as I’ve discussed before, an ETF’s market price will occasionally diverge from its net asset value. This is most likely to cause problems in the first few minutes after markets open and the last few minutes before they close. If you place an order after regular trading hours it will be executed as soon as the market opens the following day, exactly when the likelihood of a price distortion is highest.
The Toronto and New York stock exchanges are open on weekdays between 9:30 a.m. and 4 p.m. Eastern Time, which admittedly can create a narrow window for those in other time zones. If you live in British Columbia, the markets close at 1 p.m. local time, while Nova Scotians can’t place a trade until 10:30 a.m. But even if these times are inconvenient, ETF investors should make an effort to work within them—or they may wake up to an unpleasant surprise.