ETF Investors: Avoid the After-Hours Club

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.

19 Responses to ETF Investors: Avoid the After-Hours Club

  1. Simon S June 17, 2013 at 1:15 pm #

    I’m assuming this does not apply to mutual funds like the TD e-series?

    Also, I think a lot of people avoid any kind of trading at work due to possible ethical conflicts. People who are feeling uneasy about managing personal finances while at work or using work computer could consider looking into smartphone apps to do it, and you could do it on your lunch hour.

  2. Canadian Couch Potato June 17, 2013 at 2:19 pm #

    @Simon: Mutual fund orders are filled once daily after the close of trading and the price is set at the net asset value (NAV), with no bid-ask spread. With mutual funds you can also place an order with a dollar amount rather than specifying the number of shares. This is an often overlooked benefit of mutual funds as compared with ETFs: they are much easier to trade.

    If you place a mutual fund order after hours, it will be filled according to the NAV of the fund after the market closes the following day.

  3. Kevin Kane June 17, 2013 at 7:21 pm #

    Dan, thanks for the warning.

    I’m at work when the Toronto and New York stock exchanges are open (on weekdays between 9:30 a.m. and 4 p.m. Eastern Time). How risky is it for me then to place trades when the markets are closed?

    Is it a 50-50 chance that I’ll get a price distortion that will work either for or against me?

    As an aside, I’ve brought two large 30″ monitors from home into my work office. My coworkers joke that I trade stocks or watch TV online when nobody is looking. So you’re saying that I really *should* trade stocks at work? ;-)

    Thanks for your terrific wisdom and humor on this site and in MoneySense magazine.

  4. Canadian Couch Potato June 17, 2013 at 7:58 pm #

    @Kevin: I certainly don’t want to get anyone in trouble for inappropriate use of company time. :) But as a Couch Potato investor you’re probably only making a few trades a year, so perhaps it would be appropriate to take five minutes on your lunch hour. I suppose any price distortion could work in your favour, but personally I wouldn’t risk it.

  5. Amir June 17, 2013 at 8:46 pm #

    Not sure I understand the main point of this article. Up front it states to always use limit orders, which I totally agree with. Then, it seems to imply that even when using limit orders they should only be placed when the market is open, which I think is unnecessary. Is there anything wrong with putting in limit orders that lasts a month in the hope that sometime during the month the limit price will be reached? If that occurs via a market anomaly so much the better.

    Perhaps I misunderstand the article and it is just giving more reasons to use limit orders instead of market orders.

  6. Canadian Couch Potato June 17, 2013 at 9:05 pm #

    @Amir: The goal of using a limit order (for an index investor, anyway) is to avoid any surprises that can occur if the market moves suddenly. It’s not about putting in a lowball offer and hoping to get lucky. What you’re describing sounds more like market timing and is not a strategy I would recommend for a long-term investor. It’s quite possible that such a limit order would simply expire after a month without being filled.

  7. Kevin Kane June 17, 2013 at 10:22 pm #

    Dan, you said that “as a Couch Potato investor you’re probably only making a few trades a year…”

    I don’t want to get off the topic of your above article , but if you don’t mind my asking you here:

    Wouldn’t the majority of Couch Potato investors make several trades a year? At least the ones who enjoy low-transaction costs with discount brokerages such as Questrade?

    You reviewed several brokerages in your excellent June article in MoneySense and a few of these brokerages allow you to buy ETFs at no cost.

    For Couch Potato investors buying ETFs at no cost then, would you recommend that we buy ETFs as soon as we have the money to invest — say every 2 weeks when we get our paychecks?

    Maybe we don’t need to fuss every 2 weeks to make sure that our asset allocation is perfect? If our desired asset allocation is, say, one third into each of Canadian, US, and international equities, then maybe we could just invest in Canada for month 1, US in month 2, international in month 3 and repeat?

    Then maybe we could do a more rebalancing once a year?

  8. Mike D June 18, 2013 at 7:44 am #

    I am a little confused. I get the need to have limit orders, but is there truly a need in a broad based ETF to avoid after hours trading? Since one of the benefits of an ETF is diversification, then even if one company posts news that affects their stock price, the overall effect should be minimal. For example, if Bell Canada posts a surpise that causes the price of BCE to jump up, I would not expect XIC to have the same change as there are many other stocks in that ETF.

  9. Canadian Couch Potato June 18, 2013 at 8:55 am #

    @Kevin: Certainly if your brokerage offers commission-free trades you can afford to make more transactions. If you’re contributing every two weeks and paying no commissions, then sure, it makes sense to simply invest the cash as soon as its in the account. As you say, you can keep your portfolio balanced by simply adding the money to whatever asset class is furthest below its target. If the portfolio is small this may be all the rebalancing you need to do. (At some point when the portfolio is large relative to the biweekly contributions, this may not be enough.)

  10. Canadian Couch Potato June 18, 2013 at 9:09 am #

    @Mike D: The issue is not the behavior of a single company. The potential problem has to do with distortions that can cause an ETF’s market price and its NAV to temporarily diverge. These are most likely to occur in the opening minutes of trading, which is exactly when an after-hours order would be filled. There may also be a significant move in the broad market that causes prices to open sharply higher or lower, which may leave you with an unfilled order.

    I don’t mean to imply that an after-hours limit order is courting all-out disaster, especially if the order is relatively small. But it is certainly less than optimal. While working with DIY clients we have made many trades that are five or six figures, and in these cases you really don’t want to leave anything to chance.

  11. Gerry P June 24, 2013 at 11:16 pm #

    This seems like unneeded caution to me. I sometimes buy or sell this way–i.e. via after-hours orders on Qtrade–and I sometimes leave my price up for several days or a week, if needed. If I set a limit on a buy, then Qtrade will buy for me at either the market rate or my upper limit, whichever is lower. If it’s a sell, they will sell at either my low-end limit or the market price, whichever is higher. This allows me to decide what I’m willing to buy or sell for, and with a little patience, I usually get it. Sudden price fluctuations either make no difference, or work in my favour. Why is this practice not a good idea?

  12. Canadian Couch Potato June 24, 2013 at 11:36 pm #

    @Gerry P: Certainly the danger is much lower when you’re using limit orders properly. But from they way you describe what you’re doing it sounds like you’re trying to target a specific price, i.e. you’re happy to leave an order unfilled for a week or so. When you do this there is always a danger that your order will never be filled when you do this. As a passive investor looking to implement a long-term ETF portfolio (especially if the trades are large) it’s really much more prudent to do so when the markets are open and you have more control over trade execution.

  13. John V November 19, 2014 at 7:31 pm #

    @Gerry P & @CCP:
    Sorry to revive an old thread, but from my experience I *never* get a better price for my limit orders other then the price I put down as the limit price. I use RBC-DI as a discount broker, btw.
    Should I be expecting to get my ETF at a price lower then the limit price I put in, sometimes? Or is the discount broker pocketing the money between the current market price (lower) and my buy limit price (higher), in these cases?

    Thanks,
    John.

  14. Canadian Couch Potato November 19, 2014 at 7:48 pm #

    @John V: When you place your limit orders, are you setting them a couple of sense above the ask and/or below the bid? If so, you should routinely see the order filled at a lower/higher price. We use RBC Direct all the time and that’s the usual pattern. I’m not sure why your experience is different. Maybe you’re placing the limit order right on the bid or ask price?

  15. Gerry P November 19, 2014 at 9:05 pm #

    On limit orders with Qtrade, I have occasionally made a buy at a lower price than my set limit, yes. I’m not sure of the mechanism by which this happens–it may be a sudden price drop or a lower starting price on a subsequent day. Perhaps you just haven’t been lucky that way, John.

    However, I now take CCP’s advice on this issue and avoid after-hours trading of ETF’s, because there seems to be a slight risk involved– with possible sudden price changes of the underlying securities, I assume. I don’t fully understand that risk, but will take CCP’s word for it that ETF’s are subject to this risk.

  16. John V November 22, 2014 at 12:25 pm #

    @CCP: I usually don’t go outside the bid/ask range for my limit orders, but I don’t buy at the ask or sell at the bid, and always get what I put as the limit price. Though I am not a prolific trader by any means.

    So I guess you are saying that if I do put the limit price outside the bid/ask range I will often get a *better* price then the limit price out down.

    So, if the current Bid is at 1.11 and Ask at 1.20, and I put a Buy limit order at 1.09 I will get a good chance to get the buy order (if filled) to be filled at lower then 1.09? If true, that is excellent information to know.

  17. Canadian Couch Potato November 22, 2014 at 12:58 pm #

    @John V: Remember that the proper way to place limit order is to name a price above the ask (if buying) or below the bid (if selling). So in your example, a reasonable buy limit order would be 1.21 or 1.22. Most of the time you will see this order filled right at 1.20.

    The key point to understand is that you are not haggling: there’s no “better price.” Let’s assume three investors wanted to buy this ETF with an ask of 1.20. Trader A places a market order; Trader B places a limit order for 1.22; Trader C places a limit order for 1.18. The exchange does not say, “I see Trader A wants the market price so we’ll give him the shares for 1.20, but Trader B is willing to pay more, so we’ll give him the shares for 1.22. And Trader C drives a hard bargain, but we’ll give him his shares at 1.18.” What should happen is that both A and B have their orders filled at 1.20 and Trader C’s order goes unfilled.

    The reason for placing the limit order is not to get a bargain. It’s simply to avoid surprises if your quote is stale, if the market moves dramatically in a short period or time, if there is some other temporary pricing anomaly.

  18. SB November 28, 2014 at 1:55 am #

    I’m about to invest $50,000 all at once in ETFs. The above post helped me better understand ETF trading. These posts were helpful too:
    http://canadiancouchpotato.com/2010/05/14/tips-for-trading-etfs/
    http://canadiancouchpotato.com/2012/09/13/an-etf-pricing-puzzle/
    http://canadiancouchpotato.com/2013/03/18/the-etfs-price-is-right-except-when-its-not/

    I now understand that I should set a limit price a couple cents above the ask price, and I should also avoid purchasing at the early and late hours of the trading day. But what about the “duration” of the limit? Should I set it to “G.T.C”, “Day Order,” “One Week,” or longer?

    Sorry if this is newbie question, but it’s actually my very first time to trade online, and I couldn’t find any mention of this on any of the other posts.

  19. Canadian Couch Potato November 28, 2014 at 8:22 am #

    @SB: Glad these posts helped, and thanks for the follow-up question. You can simply select “day order” for your limit orders. Remember, if you place the limit order a couple of cents above the ask or below the bid it should be filled immediately. Your goal is not to set a limit order that will take days to get filled.

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