Using ETF Trailing Stop Orders in Portfolios: Watch the Price!

Over the last few weeks we've been discussing the decision I've been contemplating concerning my investment management process and the transition from using mutual funds to exchange traded funds (see “How an Advisor Can Outsource Money Management While Staying Involved,” and “When Outsourcing Investment Management Makes Sense”).

In this post, we'll conclude by touching on a few nuances involving ETFs and how it could influence my trading decisions, and yours.

As mentioned in my previous two posts, I am giving serious consideration to outsourcing a portion of my asset management, but retaining some percentage for tactical purposes using ETFs and trailing stop orders. First, let’s discuss the ETFs and TSOs.

I happened upon this by accident, but it may prove to be an interesting dynamic. One morning I noticed one of my ETF positions had sold. In short, its price had hit the TSO price and a sale was executed. I questioned it and even thought it was an error at first. However, when I pulled up a two-day chart of the ETF, it had a precipitous decline and rise in its price at the open, all in the span of a few minutes.

Now I should define 'precipitous' as I've applied it here. 

The price went from about $25.20 down to $24.85 and back up to where it started, very quickly. It appears there was a large sell order on this security waiting for the market to open which may have caused it. I called the ETF and even called my trading desk, but in the end, it was what it was. In other words, its price fell and rose as described. Moreover, this made me curious and so I checked a few other ETFs for a similar pattern. I found the exact same reaction with several ETFs. Whether this is a good or bad thing depends on how the ETF performs after it opens. 

The most important issue is how it reacted at the opening. On one hand, I could cancel the TSOs at the close, especially if the market price is close to the TSO price. However, if I do this, and the markets open sharply lower, the ETF wouldn't sell since the TSO was canceled.

For now, I think I'll pay more attention to this on the buy side and set a few limit orders to possibly catch a lower price at the opening, assuming it dips and rises as described. I'm still looking at this and gathering more data, but if it piques your curiosity and you'd like to examine it yourself, you'll need a two-day chart together with time increments as short as one minute. 

Focus on the intersection of day one’s close and day two’s opening. You should see something similar. 

Of course, I have no idea how widespread this may be (i.e.; how many ETFs), but it was definitely present in the data I viewed. Finally, setting limit orders at the opening to catch a falling price would work best when the markets are poised to rise, the very thing they haven't been doing lately. 

Until next time, thanks for reading and have a great week!

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