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Special Risks of ETFs

As already discussed, ETF share prices are sensitive to the balance between supply and demand—a risk absent from regular mutual funds. ETF investors face the additional risk of relying on authorized participants to keep ETF prices in line with the underlying share values. During fast markets—periods marked by an overwhelming imbalance between supply and demand—authorized participant firms and specialists have been known to be slow to step up and fill the wave of orders. The result is that at the time you are most anxious to sell, you might not be able to get as fair a price (relative to the value of the underlying shares) as you thought you would. The bid-ask spreads illustrated in Table 1.1 were obtained during a normal market. If you buy or sell during a fast market, your bid-ask spread costs will be higher than normal.

Actually, if you like to trade against the crowd, ETF pricing can work in your favor. You might be able to buy the ETF you want at a discount to its fair value if panic selling is occurring. If you are looking to sell ETF shares, you might be able to get more than fair value if buyers are clamoring for what you are selling.

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