Trying to Understand ETF Buy/Sell

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Kookaburra
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Joined: Thu Apr 02, 2020 11:14 pm

Trying to Understand ETF Buy/Sell

Post by Kookaburra » Fri Jul 31, 2020 1:16 pm

Hi Bogleheads

I like to understand my investments. If I can't understand or explain how something works, then I don't invest in it. In that light...

While I would like to invest in ETFs for their lower ERs and better portability, I am struggling to understand the mechanics for buying and selling. I'm hoping someone can help me understand.

Here is my limited understanding so far (please correct if I'm wrong here):

-There is a market price, and there is an underlying NAV. If market price is > NAV, the security is trading at a premium; if market price is < NAV, it is trading at a discount.
-There is a Bid price and there is an Ask Price. The bid and ask prices are what one would get if one executes a "market order" (bid for sell order, ask for buy order).

Here are my questions:

1. Is the premium/discount based on the previous day's closing NAV, or the intraday NAV? Seems like it should be the latter because comparing market price to the former is an apple to orange comparison, isn't it?
2. If the answer to #1 above is "intraday NAV", is this even known at the time one places an order (so that an investor can know if they are getting a premium or discount)? If it is known, where is it shown on the trading desk?

Let's look at an example using real numbers from today:

VUG
Market price: $214.27
Bid: $214.20
Ask: $214.25
intraday NAV: ?? (don't see it on Fidelity's interface)

What is the premium/discount?

How should one set a buy order if their goal is to avoid paying a premium or a bid/ask spread?

If one places a market order, what is the cost (in basis points) they are paying for each of the premium/discount and the bid/ask spread?

Thank you

scout1
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Re: Trying to Understand ETF Buy/Sell

Post by scout1 » Fri Jul 31, 2020 1:39 pm

All that NAV stuff isn't particularly relevant for ETFs.

An ETF works like this: an ETF issuer says "i will exchange 1 share of AAPL and 1 share of MSFT for 1 share of the Scout1 Technology ETF and vice versa any time anyone wants". If you bring them 1 share of AAPL and 1 share of MSFT, they'll give you 1 share of the ETF. If you bring them 1 share of the ETF, they'll give you 1 share of AAPL and MSFT.

Now because there are thousands of algorithms and traders in the market every day competing to make some money, if the price of AAPL and MSFT go up, the price of the ETF will go up or people will buy the ETF, exchange it for the shares of AAPL and MSFT and then sell those and make some money.

With respect to trading, just set a market order and call it a day. The algorithms will figure out the fair price for you. They compete with each other to trade with you and they know the underlying price and volume better than you do.

alex_686
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Re: Trying to Understand ETF Buy/Sell

Post by alex_686 » Fri Jul 31, 2020 1:48 pm

ETFs do post inter-day NAV. Not sure how much use they are. Most ETFs are fairly liquid and are close to the NAV. Not sure what you could do with a 15 minute delay. Not sure what I can do with access to a premium real time data service.

Having calculated NAV, I can state that it is a accountant's opinion on what the underlying value is. This is not a better price than the market price - just a different one. Actually, I am more inclined to believe the market price over the NAV price.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

SantaClaraSurfer
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Re: Trying to Understand ETF Buy/Sell

Post by SantaClaraSurfer » Fri Jul 31, 2020 1:48 pm

Someone else will have to explain NAV as it relates to buy/sell better than I can.

1. My understanding is simplistic. If you invest in ETFs that are heavily traded then the market is very efficient and this is a nonissue. I do have a couple lower volume ETFs, and I usually purchase those later into the trading day for that reason.

2. In terms of how I buy/sell. I have my list made up in advance. I wait till the market has been open for a couple hours and map out how I'm going to purchase my lots. (I use lots of 10 shares). On a down market day, I use market orders and often get a price improvement. On a day when share prices are going up, I put in a limit order.

I never worry about bid/ask premium. Esp. since what is listed publicly (Zacks or Yahoo) may not exactly match the available brokerage price in my experience. At any rate, for 10 shares, a 4 cent difference is 40 cents, so it's not a major issue.

3. In general, and I could be wrong over time, ETFs seem to have a small advantage for rebalancing events in that you can snag a very low price on days where the market is down, but still defend yourself using limit orders as prices are going up. Last Feb and March had good examples of that.

TropikThunder
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Re: Trying to Understand ETF Buy/Sell

Post by TropikThunder » Fri Jul 31, 2020 1:54 pm

scout1 wrote:
Fri Jul 31, 2020 1:39 pm
All that NAV stuff isn't particularly relevant for ETFs.

An ETF works like this: an ETF issuer says "i will exchange 1 share of AAPL and 1 share of MSFT for 1 share of the Scout1 Technology ETF and vice versa any time anyone wants". If you bring them 1 share of AAPL and 1 share of MSFT, they'll give you 1 share of the ETF. If you bring them 1 share of the ETF, they'll give you 1 share of AAPL and MSFT.

Now because there are thousands of algorithms and traders in the market every day competing to make some money, if the price of AAPL and MSFT go up, the price of the ETF will go up or people will buy the ETF, exchange it for the shares of AAPL and MSFT and then sell those and make some money.

With respect to trading, just set a market order and call it a day. The algorithms will figure out the fair price for you. They compete with each other to trade with you and they know the underlying price and volume better than you do.
All this is describes more the role of an Authorized Participant and really has nothing to do with a retail investor buying shares of an ETF. No individual person is ever exchanging ETF shares for their underlying securities, that only happens in million-dollar buckets.
Important: Small investors cannot become authorized participants
https://www.investopedia.com/terms/a/au ... cipant.asp

crefwatch
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Location: New Jersey, USA

Re: Trying to Understand ETF Buy/Sell

Post by crefwatch » Fri Jul 31, 2020 1:57 pm

You're not wrong, but the warnings you have absorbed are mainly related to CEFs, which can have, for weeks on end, massive discounts or premiums. Most premiums/discounts for ETFs tend to be self-correcting, because of the open market and creation of shares upon demand. (Not by you, but by big buyers.) It's true that small or thinly traded ETFs can have a discount/premium (for example, I have an Ex-China Emerging Market fund that isn't big enough. So I use limit orders.) But if you buy a Vanguard ETF, it's not worth worrying about. I'd only worry about Ishares or Invesco or SPDR if the product is close to brand new. If you look at the previous (or current) day's volume, this can give you an idea of how liquid it is. If a fund has been trading 100K shares a day, and you're buying 200, you may not have to worry.

Many ETFs have an artificial symbol that can tell you the momentary NAV, but you may not be able to get a really current quote for free in real time.

livesoft
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Re: Trying to Understand ETF Buy/Sell

Post by livesoft » Fri Jul 31, 2020 2:00 pm

Kookaburra wrote:
Fri Jul 31, 2020 1:16 pm
Hi Bogleheads-There is a Bid price and there is an Ask Price. The bid and ask prices are what one would get if one executes a "market order" (bid for sell order, ask for buy order).
The above is not quite a true statement. To see why, please submit a market order to buy and a market order to sell. Will you be surprised when you do not "get" the bid nor the ask price?

You are not going to get the info you want until you do this all yourself.

In the meantime, I don't understand mutual fund orders. How do I know how many shares I'm gonna get when I submit my order at 10 am in the morning? Can you help me out please?
Last edited by livesoft on Fri Jul 31, 2020 2:12 pm, edited 1 time in total.
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shess
Posts: 520
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Re: Trying to Understand ETF Buy/Sell

Post by shess » Fri Jul 31, 2020 2:04 pm

TropikThunder wrote:
Fri Jul 31, 2020 1:54 pm
scout1 wrote:
Fri Jul 31, 2020 1:39 pm
All that NAV stuff isn't particularly relevant for ETFs.

An ETF works like this: an ETF issuer says "i will exchange 1 share of AAPL and 1 share of MSFT for 1 share of the Scout1 Technology ETF and vice versa any time anyone wants". If you bring them 1 share of AAPL and 1 share of MSFT, they'll give you 1 share of the ETF. If you bring them 1 share of the ETF, they'll give you 1 share of AAPL and MSFT.

Now because there are thousands of algorithms and traders in the market every day competing to make some money, if the price of AAPL and MSFT go up, the price of the ETF will go up or people will buy the ETF, exchange it for the shares of AAPL and MSFT and then sell those and make some money.

With respect to trading, just set a market order and call it a day. The algorithms will figure out the fair price for you. They compete with each other to trade with you and they know the underlying price and volume better than you do.
All this is describes more the role of an Authorized Participant and really has nothing to do with a retail investor buying shares of an ETF. No individual person is ever exchanging ETF shares for their underlying securities, that only happens in million-dollar buckets.
True, but authorized participants provide the arbitrage that keeps the ETF from departing too far from NAV. So, as a retail investor, I don't really worry about premium and discount, because I expect that they'll be essentially a random walk over a tiny range around the underlying NAV.

rgs92
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Joined: Mon Mar 02, 2009 8:00 pm

Re: Trying to Understand ETF Buy/Sell

Post by rgs92 » Fri Jul 31, 2020 2:36 pm

An ETF trades just like a stock. Just think of it like a stock and you can see the price minute by minute by looking at the 1-day chart on Fidelity or any popular financial site (where you can also see the vital stats like P/E, yield, etc.). Some of that stats vary by site, so look at a couple, like Yahoo and Google finance and maybe others like Bloomberg. Sometimes an ETF price will vary if it's near a dividend payout date.

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