NEW YORK ( TheStreet) -- The ETF universe is expanding, and new products are launching on a weekly basis. While most large, liquid ETFs provide transparent, low-cost exposure to sectors and themes, the performance of some funds has been disappointing and even misleading for some investors. The advent of electronic trading has made it easier for individual investors to trade ETFs, but successful order execution requires more than just an idea and a computer screen. Whether you are looking to buy a large market index like the SPDR S&P 500 ETF ( SPY - Get Report) , a commodities fund like SPDR Gold Shares ( GLD - Get Report) or an international fund like Vanguard Emerging Markets ( VWO - Get Report) , the following tips will help you select "ETFs that work" and trade them successfully.
In order to test the liquidity of an ETF before purchase, investors should look at the prospective fund's average trading volume. Some very liquid ETFs like PowerShares QQQ ( QQQQ) will have three-month average trading volumes in the millions. ETFs with average daily trading volumes greater than 50,000 shares are generally liquid. Investors looking to buy a fund with lower trading volume should make sure that their order would not represent more than 10% of the trading volume on an average trading day.
There are several order types that investors commonly use when executing ETF trades. A market order, which is time sensitive but not price sensitive, executes immediately at the next bid or offer. If an ETF is liquid with a tight bid/ask spread near NAV, a market order should be sufficient to get an appropriate price. Investors who insist on trading less liquid products, with larger bid/ask spreads, may have better luck trading with limit orders. Rather than entering a market order, which sweeps the book without regard to price, investors in illiquid ETFs may be better entering a limit order at last sale. While this method does not guarantee execution, limit orders are price sensitive. By entering a limit order, you can be assured that you will not get five different prices during execution, with each price further away from NAV. The variety and complexity of ETF products requires basic knowledge of trading principles in order to get successful execution. These three tips are a good place to start. -- Written by Don Dion in Williamstown, Mass.