Factors That Influence ETF Liquidity

The ETF is a popular investment because it is considered to be more liquid than a mutual fund. However, the liquidity of an ETF can be influenced by a number of different factors. ETF liquidity is affected by both primary and secondary factors. Primary factors include what the ETF is comprised of and the trading volume of the underlying investments in the ETF. Secondary factors can include the trading volume of the ETF itself and the condition of the market. 

Underlying Investments

One of the biggest things that influences ETF liquidity is the underlying investments in the ETF. If the underlying investments trade freely and easily, you should be able to trade your ETF easily as well. For example, if you invest in an ETF that owns real estate and other tangible assets, you might find that your ETF does not have a high level of liquidity. However, if you invest in an ETF that holds mainly stocks, you should be able to sell your shares easily.

Shares Outstanding

Another factor that can influence ETF liquidity is a number of shares outstanding in the market. If the underlying stocks in the ETF are of large cap companies with many shares of stock in the marketplace, you should have no trouble buying and selling shares of the ETF. However, if you are dealing with an ETF that owns a majority of small cap companies, the liquidity may not be as good. When there are fewer shares available in the market, it can be difficult to buy and sell when you want.

Risk

Another factor that can drastically affect the liquidity of an ETF is the level of risk. If the ETF invests in extremely risky underlying investments, it may be more difficult to trade these shares. On the other hand, if the ETF puts the majority of its money into low risk securities, you should be easier to trade shares. For example, if an ETF is investing mainly in a developing country, will be a lot more risky than investing in a developed market. There will be fewer individuals to want to buy these shares and it can negatively affect the liquidity of the ETF.

ETF Volume

The volume of traders who are interested in the ETF can also have a big affect on the liquidity of an ETF. There needs to be a large number of ETF traders available on the market in order to increase the liquidity of trading an ETF. If you are dealing with an ETF that follows a well-known financial index, such as the Dow Jones Industrial Average, you should not will not have any trouble finding buyers and sellers for it. However, if you are dealing with an ETF that tracks an obscure sector of the market, it can be more difficult to find buyers and sellers.

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