An ETF Isn’t a Stock: Understanding ETF Liquidity

ETFs often get compared to stocks because they trade on exchanges and appear highly liquid. But while they share some trading mechanics, ETFs are fundamentally different. A common misconception is that if an ETF doesn’t trade a certain number of shares per day—say 50,000—it’s illiquid. That may be true for individual stocks, but not for ETFs. The key difference lies in understanding primary vs. secondary market liquidity.

Primary Market vs. Secondary Market

Most investors interact in the secondary market, where ETF shares already in existence are bought and sold between investors or market makers. The “on-screen” liquidity you see—volume and bid-ask spreads—reflects this secondary trading activity.

However, ETFs also have a primary market, where new shares can be created or redeemed to meet investor demand. This flexibility is what makes ETFs unique. Authorized Participants (APs) play a crucial role here—they can “create” new ETF shares by delivering the underlying securities to the ETF issuer or “redeem” shares by returning them in exchange for those securities.

How ETF Liquidity Really Works
The liquidity of an ETF in the secondary market depends on trading volume, average spreads, and how closely the ETF trades to its net asset value (NAV).
But in the primary market, liquidity is determined by how easily the AP can trade the ETF’s underlying holdings. If the underlying securities are highly liquid, the ETF can efficiently create or redeem shares—regardless of its average daily trading volume.
For large trades—tens of thousands of shares or more—investors can often bypass thin secondary market activity by working directly through an AP to create or redeem ETF shares.

When and How to Evaluate ETF Liquidity

For most investors, evaluating secondary market metrics such as:

• Average daily volume
• Bid-ask spreads
• Premiums or discounts to NAV

is sufficient.

However, if you regularly trade in large blocks (50,000 shares or more), you’ll want to focus on the liquidity of the ETF’s underlying holdings instead. In such cases, contacting the ETF issuer’s capital markets desk can be beneficial—they can help estimate market impact, analyze liquidity, and connect you with institutional liquidity providers.

Key Takeaways

• ETFs are not stocks—their liquidity functions differently.
• There are two types of liquidity: primary (creation/redemption) and secondary (exchange trading).
• Primary market liquidity depends on the ETF’s underlying holdings, not its trading volume.
• Secondary market liquidity depends on trading activity and market makers.
• Large investors can often access deeper liquidity through Authorized Participants.