Why Market Routs Spell Trouble for ETFs

Here’s how to handle crazy pricing on your exchange-traded fund.

Kiplinger's spoke with Tom Lydon, president of Global Trends Investments and editor of ETFtrends.com.

During market routs, the prices of exchange-traded funds can be crazy. How come?Most ETFs are based on an index of stocks. In the opening moments of trading on August 24, for instance, volume was huge, the Dow Jones industrial average was down more than a thousand points, and some of the stocks underlying ETF indexes were not priced accurately—multiple, widely held, big-name stocks. In those circumstances, it’s the natural reaction of traders authorized to make markets in ETFs to lower the price at which they’re willing to buy the ETF and raise the price at which they’re willing to sell it, widening the spread between the two. That makes it unattractive for investors to buy or sell—it’s a way of pausing trading without stopping it completely. In this case, the spread went from pennies, which is what it normally is, to dollars—in some cases, many, many dollars. The same thing happened in the 2010 “flash crash.” Back then, people thought ETFs might have been the cause of the flash crash, but ETFs were the victims of inaccurate pricing of stocks in the index they track.

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Anne Kates Smith
Executive Editor, Kiplinger's Personal Finance

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage,  authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.