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Market Timing* and Your ETF Performance
A seasoned market professional might shake their head at this title. From their perspective, they'd be right. From the perspective of an ETF investor, it's an important consideration.
*Market timing (as it relates to entering or exiting an ETF during the course of a trading day) can have a significant influence on investment outcomes. An investor who knows this can shield themselves from pitfalls and potentially improve their returns.
When choosing an entry or exit point, I recommend avoiding the market open and close because both carry heightened volatility. In many cases, higher volatility is associated with higher risk. When risk increases, the bid and ask of an ETF will respond by widening, which makes it costly to buy or sell. Increased costs eat into an investment's overall performance. Steering clear of these times should improve your return profile.
Why do these times have a greater volatility profile?
The market open is the first opportunity for markets to adjust to information that is introduced overnight. This new information includes anything from an earnings release, to a contract announcement, to an analyst upgrade.
Prior to the open, market-impacting data accumulates and pushes individual stock quotes in search of balance. Like an erupting geyser, the open is a release for this pressure. Afterwards, markets begin to normalize and react to new information as it happens, rather than building up pressure.
Like the open, the market close carries factors that increase market volatility or risk. As the end of the trading day nears, the window for completing a trade becomes smaller. Some investors will compromise on price in order to complete their trades. This may result in larger pricing swings compared to earlier in the trading day.
Several events can contribute to greater volatility during the close. These include the market on close auction, the expiry of futures and options for stock indexes, stock options, and single stock futures. These events are tied to the close, which may create large pricing swings.
Market impacting data is often released after the close. This gives investors a fair chance to review the data and assess its impact. The close offers a final opportunity for market participants to position themselves prior to this release. Think of a craps table. The close is the last chance for investors to 'place their bets'. This usually brings additional volatility to the market and ETF prices don't like market volatility.
If you avoid the first and last 30 minutes of the trading day, you may be able to sidestep periods of heightened volatility, benefit from better overall pricing, and improve your investment performance.
Another way to take advantage of market timing is to trade ETFs when their underlying markets are open. Many ETFs that trade on Canadian exchanges have non-Canadian securities within them. When underlying markets aren't open, but products based in those markets are available, the risk profile increases. This can lead to wider pricing and lower liquidity. Market participants who are interested in these products must account for potential market movement between now and when those markets will reopen. This is what widens pricing.
The market is also self-reflecting. Investors who understand that an ETF's underlying markets aren't open will avoid transacting in them. One example is a Canadian listed ETF based on the US market on the 4th of July. Although the product is available for trading, wider pricing accounts for the closed corresponding market.
Market timing also plays a role in Canadian listed Global ETFs. The liquidity profile of an ETF is highest when the maximum number of relevant markets are open. Global ETFs may hold securities from around the world, but global markets are never simultaneously open. One example is the European market, which opens and closes before our market (with a two-hour period of overlap). There is an augmented period of liquidity for Canadian investors from 9:30am to 11:30am EST. For this reason, the difference between the bid and the ask for an evenly distributed Global product may be more attractive in the morning and less attractive in the afternoon.
As a rule, investors should know whether underlying markets are open or closed. It may help save money and positively influence investment performance.
Here's my closing thought. If markets are experiencing heightened volatility, ETF pricing will be negatively affected. As a result, trading in this environment is usually unfavourable. It reminds us to avoid impulsive decision-making. In volatile times, jumping out of the market is a rash decision that becomes a poor decision over the long term.
Recently markets have been extremely volatile. The March lows saw year-to-date losses of 25%+ for major North American averages. If you exited the market at those levels, you were on the sidelines during our recent run to nearly flat. A long-term view of the markets should be rooted in logic, not emotion. This is a good way to avoid the negative aspects of market timing. Although market timing strategies aren't official investment practices, no one doubts that making smart decisions in ETF investing remains prudent.
For more information on new TD ETFs, please visit TD.com/ETFs