Understanding ETF Liquidity

Molly Landes: Intraday liquidity is often seen as a significant benefit of ETFs and often misunderstood. Understanding the different layers of ETF liquidity can help investors make smarter trading decisions. While the visible trading volume of an ETF can help to evaluate ETF liquidity, it only scratches the surface when it comes to understanding an ETF’s overall liquidity. The average daily volume, for example, is not the same thing as the ETF’s true liquidity. There are really three sources of ETF liquidity. The first level is the visible or on-screen liquidity. This represents trading activity that is visible in the secondary market and incorporates an ETF’s current bid/ask quote and the size available to trade at those prices. This is what the average investor can see on financial websites. The second level is off-screen or broker-assisted liquidity. This represents a market maker’s ability to provide a market for larger trades and includes additional levels of prices at which the ETF can be traded beyond the current on-screen quotes. The third level is the underlying liquidity and this is the bulk of ETF liquidity. This represents the creation and redemption liquidity that market makers can access through the primary market. It can work directly with an authorized participant to create and redeem large block of ETF shares directly from the ETF with little impact to the market. The creation and redemption process helps keep supply and demand in balance and leads to ETF prices that are generally in line with the value of the underlying securities. Remember, the on-screen volume of the ETF represents only what has been traded, not the full capacity of what can be executed on a given day. The Allspring Capital Markets team is available to have trading and liquidity discussions any time. We're here to help.