2. “ETFs trade exactly like stocks”
ETFs and stocks are alike in that they both trade on an exchange and the same order types apply, such as market and limit orders, but they also differ in some key respects.
Pricing
Stock prices are driven by supply and demand between investors in the marketplace. If a particular stock is popular in the market (i.e., there are more buyers than sellers), its price rises to reflect this demand.
An ETF’s trading price is based on the value of the securities held in its portfolio. Market makers calculate an ETF’s portfolio value throughout the day to determine bid and ask prices for the ETF.
Liquidity
Stocks have a set number of shares available in the marketplace. Stock liquidity largely reflects the average volume of shares trading on the market and how easily those shares can be bought and sold without affecting their price.
ETF liquidity has several components – the volume of units traded between investors on an exchange, the liquidity provided by market makers through the units they hold in their inventory and the creation/redemption process that is unique to ETFs.
ETFs are open-ended, which means that units can be created or redeemed based on investor demand. This process is managed by market makers. The liquidity posted by market makers is affected by how easily the market maker can buy and sell the securities held within the ETF’s portfolio. Thus the liquidity of an ETF is strongly related to the liquidity of the individual securities in the ETF’s portfolio. Although an ETF might have only modest trading volume, the creation/redemption process means that it is still possible for investors to buy or sell a large number of units without moving the price.