Note: While we provide quantitatively based analysis on ETFOptimize, we trade solely based on our quantitative strategies. The ETFOptimize strategies provide you with a complete, turnkey investment system that needs no additional input. It is recommended that users of systematic strategies follow the trades of their models to the letter. Doing otherwise introduces speculation and errors of human judgment into the equation, something the models work hard to eliminate.
Exchange Traded Funds (ETFs) are very different animals compared to individual stocks. For this reason, an investor's approach to minimizing transaction costs may need to be entirely different if you come from a background of individual-stock investing. If you follow the suggestions on this page, you will see lower costs, improved overall performance, and are more likely to match the performance shown by our models.
ETFs efficiently blend the investment characteristics of mutual funds with the trading flexibility of individual securities. However, it would help if you always kept in mind that ETFs trade differently than either mutual funds or individual stocks and investors need to take a slightly different approach when making transactions. This resource identifies our suggestions for the "Best Practices" for your ETF transactions.
Recommendations for Systematic Strategies Using ETFs:
1) Avoid electronic orders placed before the market open:
Market orders are automatically filled electronic orders, and these days they are usually placed with the click of a button at your broker's website. The advantage of market orders is their convenience because investors can place electronic market orders at any time of the day or night, whether the stock market is open or closed. Executed at the first available market price when the appropriate bourse is open, market orders prioritize execution over price.
However, if we can impress anything upon you in this article, it would be not to take the easy road and place an electronic order over the weekend, before the market open. You are almost guaranteed to get a poor fill price that could cost you a significant percentage of the position's gains.
It is crucial that you enter or exit the recommended ETF on or near the same day as your strategy, but not so important that you lose several percentage points from forcing the transaction. Therefore, if you place an electronic market order when you receive your ETFOptimize strategy update over the weekend, it may result in a quick and hassle-free fill at Monday's open, but there might be a problem with that...
2) Learn the Important Lessons from the 'ETF Flash Crash' of 2015
If you were an investor in 2015, you surely recall the day of the 'ETF Flash Crash,' which scared the bejeebers (*industry technical terminology) out of millions of investors. It was a real wake-up call, when the market opened on August 24, 2015, and some stocks (and subsequently, ETFs) had dropped in price by more than -40% to -50% with nearly 1,300 individual trading halts triggered. The unexpected market disruption that day caused 19% of all Exchange Traded Funds (about 350 ETFs) to temporarily decline by -20% or more.
A multi-year investigation by the SEC couldn't determine definitively what caused the ETF Flash Crash that day. However, the concept that has the most support is that two heavily-traded, individual company stocks dropped dramatically at the open on August 24 in response to a single company's terrible earnings report before the market open, triggering a pre-set trading halt, which had an enormous domino effect on many related stocks in that industry. The extreme volatility in those positions was enough to trigger preset rules that halted trading in those equities.
Those individual stocks turned out to have significant weight in several Exchange Traded Funds, which had an outsized impact on the price of those ETFs and caused general chaos across the market. Trading in almost 1/5 of ETFs was halted during the first hour of trading, based on preset exchange-volatility rules to stop just such a panic event.
ETFs are priced based on the Net Asset Value of the assets of the fund that holds the actual equities (or occasionally, a synthetic tracking) of the companies in an index. For an ETF based on a well-known and reputable index such as the S&P 500 ($SPX), it's highly unlikely – if not impossible – for an ETF to lose half its value in a few minutes. That would require the equity of a vast majority of the hundreds of companies in the S&P 500 to all – simultaneously – lose half their value.
Example: The S&P 500 Equal Weight ETF (AAPL) During Flash Crash
A company like Apple, Inc. (AAPL) – or any of the 499 other stocks in the S&P 500 – could see a significant stock price decline based on an adverse news event. It happens all the time. However, it is unimaginable that one of the world's largest and most vibrant companies – and hundreds of other S&P 500 constituents – could simultaneously lose -40% or -50% of their fundamental value overnight—but is precisely what was implied by the 2015 ETF Flash Crash.
Let's be frank: it is unfathomable that hundreds of the world's most dominant companies, such as Amazon (AMZN), Visa (V), Facebook (FB), Johnson & Johnson (JNJ), J.P. Morgan Chase (JPM), Alphabet (GOOGL), Exxon Mobil (XOM), and hundreds of other significant US companies would ALL – simultaneously – lose -40% to -50% of their market capitalization - and do so in a matter of only minutes! Because that's precisely what it would require for an index like the S&P 500 to decline by -40% to -50%. To put that likelihood in perspective, the S&P 500 has only declined by more than -10% on two days in its history; October 19, 1987, and October 28/29, 1929.
In actuallity, the S&P 500 did show a significant decline of -3.68% in the opening hour of trading on August 24, 2015 (while Apple Inc. actually gained 6.67% in the opening hour that day). However, that's not an unusually rare move – relatively speaking – and often occurs in the course of a typical day; the result of the noisy prices and animal spirits that drives investment markets.
However, when dozens of stocks dove down so sharply at the market open, automated algorithms halted trading in many equities, and a panic ensued in the indices that tracked those stocks. Since the market was opening, market makers for the ETFs tracking those indices could not price them accurately and (apparently) assumed a worst-case scenario, marking the ETFs down drastically to protect their client's assets. That's one of the big problems with ETF prices at the market open: they are best-guess estimates set by their human market-makers!
Because many investors also (inappropriately) use intraday Stop Loss Orders (see #6 below), which will sell an equity if it's price drops a penny below the amount an investor has established beforehand, brokers received massive numbers of automated sell orders on thousands of ETFs. Sufficient volume to purchase the positions had dried up because market-makers and institutional investors were confused about what was occurring. As a result, we witnessed the infamous "ETF Flash Crash."
To illustrate these events, on the right we provide a chart for the month of August 2015 with prices for two assets; the S&P 500 Equal Weight Index ($SPXEW, top) and the Invesco S&P 500 Equal Weight ETF (RSP, bottom). The ETF in the lower chart (RSP) is based on the performance of the Index ($SPXEW) in the top chart and does not include leverage of any kind.
This chart shows that on August 24 the S&P Equal Weight Index (top window) dropped by just -4% on the day, while the Invesco ETF based on that index (RSP, bottom chart), fell 10 times that amount — down a whopping -40.3% — at the open before recovering a couple of hours later. |
The Invesco Equal Weight ETF (RSP) dropped by -40% before recovering a couple of hours later.
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Can you imagine seeing your investment portfolio plummet by nearly half in a matter of minutes? That's precisely what millions ETF investors dealt with in the opening minutes of the August 24, 2015 market session. Seeing this and panicking from the classic fear of 'losing it all,' many of those investors had a knee-jerk, panic reaction, pulled the plug, and sold across the board.
Other investors who don't watch the market so closely had stop-loss orders set up on all their positions (which we vigorously advise against – see #6, below), and their holdings were automatically sold near the low that day – locking in those losses forever – rather than it just being a temporary, paper-only loss. These stop-loss orders, combined with algorithmic programs and panic selling caused markets to dive even further downward.
Other groups of investors that had market orders placed for these equities obtained deeply-discounted ownership (for a while at least) in many popular stocks and ETFs at nearly half price. The SEC had a tangled mess on its hands, and it took many months to straighten out all of those erroneous trades. However, while many had their trades reversed, not every investor was able to recoup the funds they lost – it depended upon the circumstances of the trade.
However, an investor who only got around to putting in his purchase order for RSP and other ETFs or stocks in the middle of that same day would have had no problem getting an accurate and reasonable price. That's because by a couple of hours into the day, virtually all ETF and stock prices had recovered to their normal levels.
Keep this in mind: While some of the more exotic ETFs use derivatives and representative assets, the majority of ETFs combine your funds with all other investor's funds and invest that money in the actual stocks that represent an index. For example, with the S&P 500 ETF (SPY), your money is invested in the approximately 500 largest US companies that are constituents of the index, such as Apple, Amazon, Visa, AT&T, Berkshire Hathaway, and about 495 others. That means that unless something happens during a day to cause vast numbers of America's largest companies to all – simultaneously – lose an enormous amount of there are inherent value at the same time, ETFs are not going to rapidly drop to half (or any other dramatic amount) of their value.
The only thing we might imagine that could instantly wipe out half the value of the US most successful companies would be (God forbid) a surprise nuclear attack on vast parts of American cities – something that would dramatically disrupt the normal flow of commerce in the world. Or maybe the earth falls off its axis and spins into the sun! Needless to say, the price of your ETF would probably be the last thing on investor's minds under those circumstances.
However, if you were focusing on CNBC or tracking investment markets at the open on August 24, 2015, your world may have been turned upside down for a few hours and it may have felt something like a personal catastrophe. You may have taken course-correcting actions that actually inflicted severe financial harm on you – when in reality – there was actually nothing unusual occurring. That's one of the very good reasons we advise our subscribers to ignore the financial media.
Instead, allow your quantitative investment strategy, built by investment-system designers with a combined 50 years of experience under their belts, to handle all the market-monitoring and analysis – using a combination of as many as three-dozen macroeconomic, stock fundamental, internal market breadth, and proven technical signals – to make those complex decisions for you; avoiding the worst losses and maximizing positions by identifying the optimal ETF at any given point in time, and determining the appropriate time to move to cash or defensive positions based on the weight of the evidence – not an arbitrary emotional decision driven by the fear churned up on TV.
We hope you see that the 2015 'ETF Flash Crash' was a classic and stark example of why you shouldn't trade ETFs at the market open – and also why you shouldn't place Stop-Loss Orders on your positions.
3) Optimum Time to Trade ETFs
There can be a significant difference between intraday ETF prices and their Net Asset Value (NAV) per share in the first and last hours of trading as market makers try to balance the books, leading to wider spreads and less accurate pricing.
For this reason and others, the optimum time to purchase or sell ETFs is usually in the late morning or early afternoon (avoid the opening and closing hours) on the next trading day (Monday) after your strategy recommends a transaction. The ETFOptimize strategies are updated overnight on Saturday and subscribers can view the changes on Sunday by noon. We advise that trades be made in the middle of Monday's (or Tuesday's if Monday is a holiday) after the models generate a trade recommendation. You should avoid buying or selling near the opening and close of each day's trading session.
For the ETFOptimize strategies, trading occurs at midday on Mondays after the weekend update of all models. However, if Monday is a holiday, you would make your trade on Tuesday. If for some reason you cannot execute your trade during the middle of the next day following a recommendation, you should make your trade in the middle of the first available day you can. We base pricing for all sales and purchases on a calculation that includes the average of the next day's High and Low and two-times the Closing price. This calculation is a fairly accurate representation of the price you'll attain for ETFs in the middle of the day on Monday. After trades occur on Monday, the price of the ETFs in your trade are updated in the following weekend's update of all Premium Strategy models. These prices are updated in the 'Transactions' section of the Premium Strategy pages.
4) Avoid Times of High Volatility
Wide swings in the market during times of higher risk can cause an ETF's underlying securities to move sharply higher and lower. For example, Since ETFs represent ownership in dozens, hundreds, or even thousands of individual companies, it can be nearly impossible to calculate the appropriate price of an ETF based on its Net Asset Value (NAV) when volatility is high.
For this reason, similar to market Opening and Closing Prices discussed in #3 above, the Bid-Ask Spreads for an ETF can become much broader during times of wide price swings in stocks. If a period of extreme volatility occurs on a day when a transaction is recommended to occur, you should instead avoid making the trade, and execute it as soon as volatility cools and the Bid/Ask Spread narrows.
This image is from the ETF.com website's data page for the Consumer Staples Select Sector SPDR ETF (XLP):
Screen capture of the
Bid-Ask Spread for XLP during Coronavirus selloff in March 2020.
Volatility Assessment
Without a system of assessment, it can be difficult to determine whether or not the ETF(s) you want to trade are being affected by extreme market volatility. How can you assess when volatility has calmed enough to make your trade? One effective way is to compare the current Bid/Ask Spread of an ETF to the Average Bid/Ask Spread of the ETF.
During extreme volatility in the markets, the difference between the high and low price of the an ETF and its Bid/Ask Spread can be wide.
Here are the steps to assess the spread comparison:
1) Log into your brokerage account and begin a transaction like normal, or look up the ETF of interest. View the Bid and Ask price quoted by your broker for the ETF you desire to buy or sell. The Bid-Ask Spread is the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept. An individual looking to sell will receive the bid price while one looking to buy will pay the ask price.
Subtract the Bid price from the Ask price and record the difference. This is called the 'spread.' A smaller spread is better, reducing your transaction costs. You can also calculate the percentage spread by dividing the difference between the Bid and Ask price by the On this particular day,
2) Go to ETF.com and search for the same ETF using your favorite internet browser. For a shortcut directly to the data page for that ETF, you should add a slash, then type the ticker. For example, to go directly to the data for the Consumer Staples Select Sector SPDR ETF (XLP), type ETF.com/XLP in your browser's URL window.
3) On the right side of the ETF.com data pages is a column of many data components. If you scroll down the page a bit more than halfway, you'll see a section titled "(ETF) Tradability"—in this case, "XLP Tradability" on the right side. This section includes data such as the Avg. Daily Share Volume, Net Asset Value, Creation Unit Size, and particularly, Average Spread (%), Average Spread ($).
You can access this section by typing a # sign and the word "Tradability" after the URL mentioned above for a particular ETF. For example, to access the Tradability section for XLP, use this URL in your browser: "https://www.etf.com/XLP#tradability."
5) Commissions
Minimizing the transaction costs you incur is one of the easiest ways to improve your portfolio's performance over long timeframes. Saving on your transaction cost of each trade – when accumulated over your earning lifetime of 30 or 40 years – can add up to a surprisingly large amount of money. Especially when you consider the magic of compound interest over long periods, a consistent, small percentage reduction in transaction costs can add up to an enormous financial gain, depending on the size of your portfolio.
Update to This Section: As of October 2019, when virtually all major brokerages reduced commissions on stocks and ETFs to $0, ETFOptimize also began recording a commission of $0 each way (both buying and selling) as a standard commission on all trades.
6) Limit Orders:
For the typical investor, it's a good idea to use limit orders on your buy-and-hold ETF trades. However, the objectives of trade entry and exit are different from quantitative ETF strategies. We are not able to provide you specific guidance on a limit order to use on each of your individual ETF trades, so – assuming you are accustomed and determined to use limit orders – you should prioritize getting a reasonable fill on each transaction over getting the best possible price.
The most critically essential criteria for your transactions when using an ETFOptimize strategy is that you make transactions on the day after it's recommendation. Since recommendations are provided on the weekend, you should be making your trades in the middle of the day on Mondays (or Tuesday if Monday is a holiday). And unless an extreme event has occurred on a Monday morning that causes aberrant volatility (see #3, above) in the overall market or a particular ETF, you should be able to get a price that is near the same price obtained by the model (it's not feasible nor necessary for these to be identical).
Making your trade on the date and at the approximate price estimated in the recommendation are the two most important criteria for success with a quantitative strategy – not minimizing the cost or fractionally maximizing the profit on each transaction. Optimizing by a few pennies or a few 10ths of a percent on entry/exit prices during transactions is far less critical than the fact that you actually EXECUTE THE TRANSACTION on the day recommended.
Instead of trying to optimize your trades fractionally, you should instead use limit orders to avoid purchasing during rare, extreme price volatility events (such as occurred during the ETF Flash Crash, discussed above). If you use a limit order, make sure it is reasonab'sle and will likely get filled. You don't want to purchase in the face of extreme volatility, but most of all, you want to be sure your order goes through on Monday if there hasn't been an outlier event.
7) Avoid Intraday Stop-Loss Orders:
You should DEFINITELY NOT apply your broker's Stop-Loss Orders to your ETF positions! This subject is an issue upon which ETFOptimize management has a firm opinion, especially with our background in systematic investment models that have carefully assessed thresholds for purchasing and selling ETFs—which do not consider intraday price movements.
Think About the Reality of a Stop Loss Order: It involves setting an arbitrary dollar amount or an arbitrary percentage at which you will sell a position based on what you assess to be your pain threshold for a loss on the position, assessed at that particular moment in time. Tomorrow or next week your financial-pain threshold may be far different than it is today when you enter the order. Most intraday stop loss orders are inherently arbitrary and don't contribute to systematically maximizing your long-term investment goals.
The bottom line is that Stop Loss Orders are almost always idiosyncratic, arbitrary decisions that are not carefully calculated nor statistically tested for profitability – making them neither prudent nor effective. Worst of all, Stop Loss Orders negate virtually all of the multifaceted benefits built into your carefully constructed quantitative investment strategy. By placing a 'percent-from-high' stop loss order on the positions recommended by your ETFOptimize strategy, you risk trading when you shouldn't, and throwing out the potential profits you could have recorded on a trade if you headset your Stop Loss a few pennies lower.
It's possible that new could make a viable argument for placing loose Stop Loss Orders on individual stocks; something to prevent a financial disaster in the worst-case scenario. After all, the sometimes small, somewhat illiquid company stocks that offer the most potential for gain, also offer the greatest risk of loss. One bad earnings report, or a concern expressed by the CEO looking forward, can tank a stock in a matter of minutes. Plus, how are you going to keep track of the news affecting the dozens of individual companies you need to have in your portfolio to attain adequate diversification? In that situation, the classic Stop Loss Order is cheap insurance against losing it all.
However, as discussed earlier in recommendation #2) Lessons from the ETF Flash Crash, above, we explain how ETFs are priced and the reasons why the ETFs used in the ETFOptimize investment strategies
ETFs and stocks should not be traded based on how you are feeling. Instead, your ETFOptimize strategy has been designed to make prudent decisions driven by accurate, quantitative signals from as many as three dozen different macroeconomic, stock fundamental, internal-market breadth, and proven technical signals. These indicators work in a carefully constructed decision-framework, and if it is appropriate to sell a position, your strategy will sell it – at the proper time and at a price that will optimize the overall performance of your strategy.
By placing arbitrary Stop Loss Orders on your positions that override your strategy's design, you negate all the effectiveness and multi-faceted benefits of your quantitative investment strategy. Our policy on stop-loss orders – in one word: DON'T.
Discover more reasons to never use a Trailing Stop Loss in this blog post.
More Suggestions for Your Success
For more suggestions on how to get the optimum benefit and success from your quantitative, ETF-based investment strategy, please see this section in our Welcome Letter. As always, if you have any questions, concerns, or suggestions, please let us know with Support Ticket.
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The ETFOptimize quantitative investment strategies have a proven track record of consistently high-performance success over long periods. Our premium model strategies have provided an average annual return of 30.53% since their inception – which is a multiple of more than quadruple (415%) the long-term annual return of the S&P 500, and more than eight times more than the index' return since 2000. The ETFOptimize strategies, collectively, have beaten the S&P 500 in 64 of 66 years (97%)!
The ETFOptimize strategies operate using our proprietary, quantitative financial-analysis programming that has been continuously upgraded and refined over the last 25 years, accompanied by high-speed computer servers and high-quality, point-in-time investment and economic databases. As ETFs were developed and became so incredibly popular, we've adapted our approach to embrace these instantly-diversified products.
Why not look over our strategy lineup now and see which one is the best fit for you? It's actually straightforward and affordable to put a high-performance investment strategy to work for you every week of the year. The ETFOptimize models are available by subscription starting at just $9/mo.
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Look around the Internet; we don't think you'll find a superior approach to investing – offered at such an exceptionally low cost, and making consistent, high-performance investment results affordable for even the smallest investor. You keep your money in your account and follow our clear instructions for trades, which occur only about three times per year. We provide you with weekly updates of your strategy and an analysis of the market that always tells you what's critically important.
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Take a moment to sign up for the strategy of your choice now – while all the benefits of a quantitative approach are fresh in your mind. You can get started for less than 50-cents a day with a very low-risk, high-profit investment strategy that produces solid performance through thick and thin – in any type of market environment.
Moreover, remember that you have nothing to lose – if you change your mind anytime in the first two months – for any reason (or no reason at all) – just let us know and we'll return every penny you paid! Visit our ETF Investment Strategy Suite today and select the quantitative strategy that's perfect for you:
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