When Is the Best Time to Buy an ETF?

When is the best time to buy an ETF? Did you know you shouldn't buy ETFs in the last 10 minutes before the market closes? From 10 minutes before the close, you're more likely to pay a price higher than the ETF's actual value. Why is that? And if so, when is the best time to buy an ETF?

The True Nature of ETFs You Didn't Know About

An ETF is a product that bundles multiple stocks together. The sum of each stock's price becomes the ETF's fair value. However, since an ETF is a type of fund, it deducts management fees. For example, if an ETF's management fee is 1%, that fee is divided by the number of trading days and deducted little by little each day.

As a result, the actual value of an ETF is the value of the stocks it holds minus the fees. This actual value is called the net asset value, or NAV for short, which stands for Net Asset Value.

Changes in Actual Value and Market Price

But because ETFs trade in real time just like stocks, an ETF's actual value keeps changing as well.

For example, if the share price of LG Electronics in a KOSPI 200 ETF surges, the value of the KOSPI 200 ETF should rise along with it. The Korea Exchange calculates this actual value of ETFs during trading hours every 10 seconds and provides it as the indicative net asset value (iNAV).

So to buy an ETF at a fair price, you need to buy it at a market price that's as close as possible to this constantly changing iNAV.

Premium/Discount Rate and ETF Prices

However, the price actually traded on the market can differ from the iNAV. This difference is called the premium/discount rate (tracking gap).

When this rate is high, investors end up buying an ETF for more than its actual value or selling it for less than its actual value. This can lead to buying and selling ETFs at unfair prices.

The Role of the Liquidity Provider (LP) System

To prevent this, the exchange operates a liquidity provider (LP) system. An LP buys or sells ETFs in the market when necessary to keep the ETF's market price stable. This reduces each ETF's price volatility and helps protect investors.

Why You Shouldn't Buy ETFs Near the Close

However, during the last 10 minutes before the market closes, from 3:20 PM to 3:30 PM, LPs are not obligated to provide quotes. Why is that? It's because the stocks underlying the ETF collect buy and sell orders for those 10 minutes and are then executed at a single price.

In this situation, LPs can't properly calculate the ETF's value, so they aren't obligated to provide liquidity. As a result, in the last 10 minutes before the close, the ETF's value can't be calculated properly and may become unstable. This can create a large gap between the ETF's actual value and its trading price.

In conclusion, it's best not to trade ETFs during the last 10 minutes of the market. During this time, the price actually traded on the market can differ greatly from the ETF's actual value.

How to Buy ETFs at a Fair Price

So to buy ETFs at a fair price, you can consider the following approaches.

1. Trade during market hours: If you trade during regular market hours, you can buy ETFs while LPs are providing quotes.
2. Choose ETFs with high trading volume: ETFs with high trading volume are more likely to trade at accurate prices on the market.
3. Check the iNAV: By checking an ETF's iNAV before buying, you can estimate a market price close to its actual value.
4. Use limit orders: To buy an ETF at a fair price, you can use a limit order to place your order at the price you want.

Wrapping Up

Let's sum up. To buy ETFs at a fair price, it's important to trade during market hours, check the iNAV of ETFs with high trading volume, and use limit orders. Also, since LPs don't provide quotes during the last 10 minutes of the market, it's best to avoid trading ETFs during that time.