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Let's say it's an index tracking ETF. Isn't the ETF price determined by the index value? Why does it have bid/ask spread then? Could someone explain the bid/ask concept when trading ETFs.

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The price of ETF is determined by index value. This is generally calculated after market closes.

When the market is open if enough people holding ETF believe markets will go up, they will ask more. There are a bunch who believe it will go down or not go as high as others think and will bid low.

This results in spread. As no one can predict the exact value the EFT will end on close of markets, the ETF behaves similar to stock, the only difference being it will not deviate to much from the actual value.

  • Indexes are commonly calculated throughout the trading day, not just at the close. More specifically, the assets underlying the ETF trade throughout the day. This answer misses that ETFs are priced in real time through arbitrage. – nanoman Jan 22 at 23:09
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Isn't the ETF price determined by the index value?

Technically ,the price is determined by the market's view of the ETF's assets, which is supposed to track some index. It consists of numerous stocks The price does not necessarily have to match the index exactly.

Take SPY as an example. It's current value is 264.15, while the S&P 500 sits as 2647.60, so not quite a 1:10 ratio. If you compare the two on a finance site, you'll see that the normalized graphs are very close, but do have some deviation. In fact, SPY posts a tracking error of 0.05, which means that on average, the ETF price is about 0.05 above or below the actual index value.

Why does it have bid/ask spread then?

Like any other stock, the bid/ask spread is determined by the limit orders for that index, with buy limit orders filling the "bid" queue and sell limit orders filling the "ask" queue.

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    This answer could be strengthened by noting that the ETF is a traded security that is priced via arbitrage with its underlying assets (unlike index mutual funds which are priced by the fund sponsor at NAV rather than independently traded, and seem to be OP's reference point). Much of the ETF's bid and ask liquidity is provided by arbitrageurs. This is a different and creative mechanism that exploits market forces to construct an index-tracking product, and has only been around for 25 years or so. – nanoman Jan 22 at 23:02

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