Avoid the 'First-Hour' Trap of ETFs

06/18/2014 9:00 am EST

Focus: ETFs

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and ETFU.com

When it comes to investing with ETFs, things couldn't really be much easier; however, there still are a number of trading tips that will make your ETF trading more successful, explains Doug Fabian, editor of Successful ETF Investing.

We want to help you avoid some of the most common mistakes that novice—and even sophisticated—investors sometimes make when buying and selling exchange-traded funds.

I recently conducted a workshop at the Las Vegas MoneyShow about ETF investing and was amazed at how many questions I received regarding the mechanics of buying ETFs.

One of the questions I received really resonated with me, and the question had to do with what the best time of day was to buy or sell an ETF. This is a great question.

Unlike buying mutual funds that only price out once per day, and at the end of the day, the price of an ETF can vary intraday, and often quite a lot.

This situation really gets messy when you are dealing with emerging-market ETFs, or with ETFs pegged to China or other international markets where the underlying index of an ETF is based on the trading that takes place overnight in a market.

Many times, and particularly over a weekend, there is news-driven action in overseas markets that influences the initial price of an ETF here at home as soon as the market opens.

This influence can take the form of an ETF opening much lower than it otherwise would. It also can lead to a situation where many buy or sell orders are backed up from the night before, and hence you get a skewed “fill” price (sometimes in your favor, and sometimes not).

The potential hazard here is that if you have a buy order pending, and the price of that order gets skewed artificially higher, then you may end up owning the ETF at a much higher price than you actually should have.

In many cases, after the initial run-up in an ETF price takes place, the order flow “rights” itself, and then the price comes back down to a more logical level.

This situation happens because the market needs a little time to sort out the buys and sells. Pricing is the mechanism by which this is done.

To avoid getting your ETF buy or sell orders filled at an unfavorable price, I recommend never buying a fund in the first hour of trading.

By waiting until 10:30 AM EST to place a buy or sell order, you evade that first-hour potential price fluctuation. Therefore, you avoid getting a poor “fill” on your order. By doing this, we will ensure that we avoid that first-hour trap, as well as the overnight bias that can materially affect our bottom line.

So, the lesson here is to never buy or sell an ETF during the first hour of trading. Rather, wait until the first hour is over. Then you can buy or sell your fund anytime during the day thereafter.

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