Authored by Wade Guenther, Will Cai, Alexander Chang

Exchange-traded funds (“ETF” or “ETFs”) have been around for a few decades. However, there are still questions around ETF liquidity that are causing hesitation when it comes to ETF investment and trading, particularly with ETFs that have low trading volumes. Below is a deep dive into ETF liquidity that examines various common metrics and how they apply to ETFs. We will address how some of these metrics can be misleading for ETFs, especially as they relate to newly launched ETFs. Throughout the discussion, we will examine and compare a newly launched hypothetical gold ETF versus a hypothetical larger, more established, gold ETF.

Trading Volume – A Topical Measure

Many people use trading volume, which can be the number of shares traded, or average daily volume (“ADV”), as the primary indicator of liquidity. Trading volume can be easily obtained and can be used as a quick gauge of liquidity, but it has major drawbacks. Trading volume, generally, is a historical measurement of how many shares were traded, not necessarily how many shares can be traded currently. An extreme example would be that for a stock early in the trading day with zero shares traded but with 100,000 shares on both bid and offer (100,000 x 100,000), meaning one could buy or sell 100,000 shares easily. The stock’s liquidity certainly was not zero as its trading volume would be indicating.

On a trading day, the hypothetical new gold ETF traded a total of 2,000 shares with a closing price of $17.78, for example. The larger hypothetical gold ETF could trade millions of shares a day. Let’s assume it traded 7 million shares with a price of $150.00, then it could suggest that the larger hypothetical gold ETF was about 30,000 times more liquid than the hypothetical new gold ETF, in dollar terms.

Order Book – A Better Measure

Bids and offers are part of the order book, where one can buy or sell stocks and ETFs in the secondary market. Retail customers often only see the national best bid and offer (“NBBO”), aggregated across all trading venues and market participants.

National Best Bid and Offer Example

National Best Bid and Offer Example. Hypothetical New/Smaller Gold ETF

Source: Wilshire Phoenix. For illustrative purposes only.

For example, investors may see the hypothetical new gold ETF bid and offer at 3 x 3 lots, which means 300 shares were available at the best bid and offer (each lot is 100 shares).

However, best bids and offers are only one level of the order book. Level II order book data could reveal bids and offers at different prices levels, which often shows more liquidity.

National Best Bid and Offer Example. Hypothetical New/Smaller Gold ETF

Source: Wilshire Phoenix. For illustrative purposes only.

In the example above, 3 lots of the hypothetical new gold ETF were bid at $17.80 and 30 lots at $17.79. The bids and offers represent market liquidity that one can easily buy and sell with a click of a button, even if trading volume was zero. Furthermore, there could be hidden liquidity that isn’t reflected in the order book as market participants could enter a very large order but only display a small portion of the order to not show their hands.

Below is a sample comparison of the hypothetical new gold ETF and the hypothetical larger gold ETF’s order books:

Hypothetical New Gold ETF and the Hypothetical Larger Gold ETFs Order Book

Source: Wilshire Phoenix. For illustrative purposes only.

From this snapshot, the hypothetical new gold ETF’s order book shows liquidity of 3300 x 3300 shares with a total dollar amount of approximately $120,000 available for trading. The hypothetical large gold ETF’s order book shows liquidity of 4500 x 3800 shares with a total dollar amount of approximately $1,200,000 available for trading. The hypothetical large gold ETF order book liquidity, in this example, was about 10 times more liquid than the hypothetical new gold ETF.

So far, our discussions on liquidity measures using trading volume and order book apply to both regular company stocks and ETFs. However, while one could trade ETFs just like stocks, ETFs offer a significant difference and advantage versus stocks when it comes to liquidity.   

Implied Liquidity – Creations and Redemptions

A company stock usually has one primary issuance, the Initial Public Offering (“IPO”), then the stock trades on secondary markets, which are the stock exchanges. ETFs are different because ETFs have the creation and redemption process that allows daily and direct access to the primary market, which is the ETF sponsor. The direct access to continuously create (buy) and redeem (sell) ETF shares at fair market prices (at daily Net Asset Value) represents a significant source of liquidity for ETFs.

A market maker, who provides liquidity to the secondary market by quoting two-way prices, usually needs inventory of ETF shares to satisfy potential buy orders. However, when an ETF market maker1 has a large buy order and not enough ETF shares in supply, they could access the ETFs primary market. The market maker could create ETF shares with the sponsor for the amount needed and purchase the ETF’s underlying holdings to hedge. The market maker will deliver the underlying ETF holdings to the sponsor and receive the ETF shares in return. This ability to create and redeem directly from the sponsor means an ETF’s primary market liquidity can be limited only by the liquidity of the ETF’s underlying holdings, which is the implied liquidity1. However, disruptions in the ability to create or redeem ETF units may adversely affect investors.

In the hypothetical new and large gold ETF examples, the order books seem much less liquid for the hypothetical new gold ETF. However, both ETFs represent an investment in physical gold bars, and both ETFs offer daily creation and redemptions. The implied liquidity should be exactly the same for both as they are limited to the liquidity2 of the underlying physical gold in the ETFs and closely related hedges, i.e., gold futures.

According to the LBMA, the 12-week moving average of physical gold turnover was $290 billion as of June 20, 20213. That equates to an average daily physical gold turnover of $4.83 billion. Further, CME COMEX gold futures have often been considered one of the most liquid commodity futures. CME COMEX gold futures offers quick and efficient hedging to physical gold for market participants that do not have direct access to physical gold trading. According to the World Gold Council, 2020 total gold liquidity ranked between U.S. Treasury Bills and the S&P 500® Index4.

Conclusion – Deep ETF Liquidity

A newly issued ETF, hypothetical like our example or otherwise, may appear to have low liquidity as measured by trading volume or even by the exchange bids and offers in the order book, but it can have massive liquidity support through the ETF creation and redemption process that equals the liquidity of the largest physical gold ETF in the U.S. The high gold liquidity means that for a newly launched gold ETF, even though it has limited exchange trading activity, investors, through Authorized Participants (“APs”), can trade a significant number of ETF shares at fair market values on a daily basis.


[1] Often implied liquidity of an ETF (through the primary market) could be much larger than the liquidity reflected in its exchange order book (secondary market).
[2] For ETFs holding multiple underliers, the implied liquidity would be the liquidity on the least liquid underlier within the ETF.
[3] LBMA Weekly Turnover
[4] World Gold Council Trading Volumes


Important Disclosures

This material must be preceded or accompanied by a prospectus. Please read the prospectus https://bit.ly/wSharesWGLD carefully before investing.

The shares of the Fund (the “Shares”) may trade at, above (a premium), or below (a discount) the net asset value (“NAV”) per Share and are not individually redeemed from the Fund. The NAV per Share will fluctuate with changes in the market value of the physical gold (“Physical Gold”) owned by the Fund. The price of gold is volatile and his­torical fluctuations in gold prices are not a reliable indicator of future gold price movements. Since the Index seeks to reduce the risk-profile typically associated with the purchase of gold while maintaining the correlative benefits of gold versus the equity markets, neither the Index nor the Fund is designed to precisely correlate with the actual performance of gold. Therefore, an investor in Shares may not be able to achieve a return that precisely correlates with the return an investor may achieve by investing directly in gold.

There is no guarantee that the high trading price of gold will be sustained. The Share price reported under “WGLD” is not the same as the intraday indicative NAV (“INAV”); the INAV may vary significantly from the Share price, partic­ularly during times of volatility of gold prices. The Index level calculated and published by approximately 7:00 pm (New York City time) under “WGIX” is not the same as the intraday indicative value for the Index (“IIV”); the IIV may vary significantly from the Index level, particularly during times of volatility in gold prices. An investment in the Shares may be adversely affected by competition from other methods of investing in com­modities, and the availability of other gold products.

The Fund may terminate and liquidate at a time that is disadvantageous to Shareholders. The Share price will fluc­tuate with changes in NAV per Share as well as market supply and demand. The amount of discount or premium in the Share price relative to NAV per Share may be affected by non-concurrent trading hours between NYSE Arca, Inc. (the “Exchange”) and major gold markets. While the Shares will trade on the Exchange until 4:00 pm (New York City time), liquidity in the market for Physical Gold may be reduced after the close of major world gold markets including London and other locations. Depending on the price at which an investor purchased its Shares and whether the Shares trade at a discount or a premium to NAV may affect the investor’s gain or loss on its investment in the Fund when Shares are sold. Investment return and principal value of an investment will fluctuate so that an investor’s Shares, when sold or redeemed, may be worth more or less than the original cost. Purchases or sales of Shares may be subject to brokerage commissions, which will reduce returns.

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