If you are a big shot and you find that you trade this size regularly, a good first step is to contact the ETF issuer itself and request the capital markets desk. One of the main goals of the issuer's capital markets desk is to ensure that investors enter and exit funds at fair prices. They can also be a great help in providing underlying liquidity analysis and connecting investors to liquidity providers.
For individual stocks, liquidity is usually defined as trading volume and how regular that volume is turned over. For investors and traders, more is better. For ETFs, there's a lot more to consider.
First off, an ETF isn't a stock. ETFs are often praised for their liquidity and single-stock trading characteristics. The truth is, in this aspect they are similar.
If an ETF doesn't trade a certain number of shares per day (say, 50,000 shares), the fund is usually labeled "illiquid" and should be avoided, right? Wrong. If we were talking about single stocks then we would agree, but with ETFs, we need to go a level deeper. The key is to understand the difference between the primary and secondary liquidity of an ETF.
Most non-institutional investors transact in the secondary market. This is a fancy way of saying that investors are trading the ETF shares that currently exist. Secondary liquidity is the "on screen" liquidity you see from your brokerage platform, and it's determined primarily by the volume of ETF shares traded.
However, one of the key features of ETFs is that the supply of shares is flexible. Shares can be "created" or "redeemed" to offset changes in demand. Primary liquidity is explained as how efficient it is to create or redeem shares. Liquidity in one market, primary or secondary, is not a fair indicator of liquidity in the other market.
Another way to make the distinction between the primary market and the secondary market is to understand the participants in each. In the secondary market, investors essentially negotiate with each other or with a market maker to trade the existing supply of ETF shares. In contrast, investors in the primary market use an "authorized participant" (AP) to change the supply of ETF shares available. This may be a sell order of a large basket of shares ("redeem" shares) or a firm looking to buy a large basket of shares ("create" shares).
What determines primary market liquidity is different than what determines secondary market liquidity. In the secondary market, liquidity is generally a function of the value of ETF shares traded. In the primary market, liquidity is more a function of the value of the underlying shares that back the ETF.
When placing a large trade, (were talking tens of thousands of shares) investors are sometimes able to circumvent an illiquid secondary market by using an AP to reach through to the primary market to "create" new ETF shares.
Unfortunately, most of us aren't trading tens of thousands of shares at a time, so we're stuck trading in the secondary market. Remember that, to assess secondary market liquidity, you should be looking at statistics such as average spreads, average trading volume, and premiums or discounts (does the ETF trade close to its net asset value?).
It's really only if you'll be trading close to 50,000 shares or more at a time that these statistics are no longer the most relevant in assessing liquidity. For those big trades, the liquidity of the ETF's underlying securities is the most important factor.
If you are a big shot and you find that you trade this size regularly, a good first step is to contact the ETF issuer itself and request the capital markets desk. One of the main goals of the issuer's capital markets desk is to ensure that investors enter and exit funds at fair prices. They can also be a great help in providing underlying liquidity analysis and connecting investors to liquidity providers.
