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3 Important Lessons From The ETF Flash Crash

The U.S. stock market saw extreme volatility on Monday, August 24th, with some crazy trading after market open. Many stocks declined sharply and many ETFs fell 20% or more and some as much as 30%-45%, even though their underlying stocks had not declined so much. ETFs are baskets of securities and they usually trade close to the aggregate value of their holdings. Significant dislocations from their NAVs are rather unusual for ETFs. However that morning, large dislocations in ETFs’ prices were seen not only in smaller ETFs but in some very large and popular ETFs as well. While these discrepancies lasted only for a short period of time, none of the trades executed during that time were canceled. There were many factors that caused ETFs’ pricing problems. To begin with, NYSE invoked rule 48 at the open, which in simple words meant that designated market makers did not have to disseminate indicative prices before the open. The rule was meant to ensure a faster and more orderly open. Then due to excessive volatility, many stocks and ETFs were halted for trading. Per WSJ, nearly 80% of about 1,300 trading suspensions were for ETFs. Total trading halts reported on Monday were almost 40 times the daily average this year. Further, many stocks listed on the NYSE did not start trading for more than 10 minutes while BATS and NASDAQ exchanges started trading at the open. In other words, many ETFs were trading while their underlying stocks were not. A combination of all these factors made it difficult for market-makers in ETFs to determine the right price for underlying assets and price ETFs accordingly. This caused them to price ETFs with very wide bid-ask spreads or just stay away from the market, since they did not want to take on too much risk when arriving at fair prices was so difficult. There were some important takeaways for investors from extreme volatility seen that day. First of all, investors should not try to sell in panic; they should plan and then act accordingly. They should stay focused on their long-term investing goals. And most importantly, investors should remember to use “limit orders” in volatile markets. Link to the original article on Zacks.com Share this article with a colleague

How To Find The Best Style ETFs: Q3’15

Summary The large number of ETFs hurts investors more than it helps as too many options become paralyzing. Performance of an ETFs holdings are equal to the performance of an ETF. Our coverage of ETFs leverages the diligence we do on each stock by rating ETFs based on the aggregated ratings of their holdings. Finding the best ETFs is an increasingly difficult task in a world with so many to choose from. How can you pick with so many choices available? Don’t Trust ETF Labels There are at least 67 different All Cap Blend ETFs and at least 281 ETFs across twelve styles. Do investors need 23+ choices on average per style? How different can the ETFs be? Those 67 All Cap Blend ETFs are very different. With anywhere from 4 to 3794 holdings, many of these All Cap Blend ETFs have drastically different portfolios, creating drastically different investment implications. The same is true for the ETFs in any other style, as each offers a very different mix of good and bad stocks. Large Cap Value ranks first for stock selection. Small Cap Blend ranks last. Details on the Best & Worst ETFs in each style are here . A Recipe for Paralysis By Analysis We firmly believe ETFs for a given style should not all be that different. We think the large number of All Cap Blend (or any other) style ETFs hurts investors more than it helps because too many options can be paralyzing. It is simply not possible for the majority of investors to properly assess the quality of so many ETFs. Analyzing ETFs, done with the proper diligence, is far more difficult than analyzing stocks because it means analyzing all the stocks within each ETF. As stated above, that can be as many as 3794 stocks, and sometimes even more, for one ETF. Any investor worth his salt recognizes that analyzing the holdings of an ETF is critical to finding the best ETF. Figure 1 shows our top rated ETF for each style. Note that there are no ETFs currently under coverage in the All Cap Growth or All Cap Value styles. Figure 1: The Best ETF in Each Style (click to enlarge) Sources: New Constructs, LLC and company filings How to Avoid “The Danger Within” Why do you need to know the holdings of ETFs before you buy? You need to be sure you do not buy an ETF that might blow up. Buying an ETF without analyzing its holdings is like buying a stock without analyzing its business and finances. No matter how cheap, if it holds bad stocks, the ETF’s performance will be bad. Don’t just take my word for it, see what Barron’s says on this matter. PERFORMANCE OF ETF’S HOLDINGS = PERFORMANCE OF ETF If Only Investors Could Find Funds Rated by Their Holdings The Arrow QVM Equity Factor (NYSEARCA: QVM ) is the top-rated Large Cap Blend ETF and the overall best ETF of the 281 style ETFs that we cover. The worst ETF in Figure 1 is the State Street SPDR S&P 600 Small Cap Growth (NYSEARCA: SLYG ), which gets a Neutral rating. One would think ETF providers could do better for this style. Disclosure: David Trainer and Max Lee receive no compensation to write about any specific stock, style, or theme. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.