The Market for ETFs

The market for exchange-traded funds is larger and more complex than the experience most investors see on a brokerage screen. A retail investor may place a single order for an ETF and receive a fill within seconds, but that trade sits on top of a market structure that connects exchanges, brokers, market makers, authorized participants and the securities or other assets held by the fund. Understanding that structure helps explain why ETF prices usually stay close to portfolio value, why some ETFs trade more efficiently than others and why trading volume alone does not tell the whole liquidity story.

Exchange traded funds, or ETFs are often described as funds that trade like stocks, which is useful as a starting point but incomplete as an explanation of the market. The stock-like feature belongs mainly to the secondary market, where existing ETF shares change hands among investors. Behind it is a primary market in which large financial institutions can create new ETF shares or redeem existing ones in large blocks, linking the supply of ETF shares to the fund’s underlying portfolio.

The ETF market has two connected layers

Most individual investors participate only in the secondary market. They submit orders through brokers, and those orders can interact with other investors, market makers and trading firms on exchanges or other trading venues. The price is determined by bids and offers in the market, so an ETF’s share price moves throughout the trading day instead of being fixed at the fund’s end-of-day net asset value.

The primary market works differently. Authorized participants, commonly called APs, are large broker-dealers or other financial institutions that have agreements with an ETF to create or redeem large blocks of shares. A creation generally increases the number of ETF shares outstanding, while a redemption reduces it. Retail investors do not normally submit creation or redemption orders themselves, but the existence of this mechanism affects the prices and liquidity they encounter in the secondary market.^[1]

The two markets are connected rather than independent. If demand for an ETF rises sharply in the secondary market, APs and other professional participants can respond when economic conditions make a creation attractive. If ETF shares become abundant relative to demand, redemptions can reduce supply. The mechanism is important because it gives the ETF market a way to expand and contract that an ordinary company’s fixed share count does not provide.

Creation, redemption and arbitrage help connect price to value

An ETF owns a portfolio, and the value of that portfolio is reflected in the fund’s net asset value, or NAV. The market price of the ETF is established separately through trading. Those two values are related, but they are not required to match at every instant, which is why ETF shares can trade at a premium to NAV or at a discount to NAV.

Professional trading firms watch the relationship between the ETF and the securities or other assets that make up its portfolio. When a meaningful price difference appears and the underlying assets can be traded efficiently, arbitrage activity can make it profitable to buy the cheaper side and sell the more expensive side. Creations and redemptions allow APs to convert between ETF shares and baskets of underlying assets, helping close price gaps when the economics support the trade.

This process should not be treated as a promise that every ETF will always trade exactly at NAV. Arbitrage itself has costs, and the underlying holdings may be difficult to price or trade, especially during market stress or when foreign markets are closed. A bond ETF, an international ETF and a highly liquid U.S. equity ETF can therefore show very different premium, discount and spread behavior even though all three use the same broad ETF structure.

The old version of this article treated market makers as if they were essentially the fund managers who earn their return from trading the ETF. The roles are more distinct. The ETF sponsor organizes and manages the fund, APs have the contractual ability to create or redeem shares, and market makers stand ready to buy or sell in the secondary market. A firm can perform more than one of these functions, but they should not be collapsed into a single role because each affects the market in a different way.

Liquidity is more than the number of ETF shares traded

ETF liquidity is often judged by average daily volume, and volume is useful because active trading can support tighter spreads and make it easier to execute ordinary orders. It is not a complete measure, however, because ETFs have two layers of liquidity. Secondary-market liquidity comes from trading in ETF shares, while primary-market liquidity is connected to the creation and redemption process and, ultimately, to how easily the underlying basket can be traded.^[2]

This distinction matters when comparing a large, heavily traded ETF with a smaller fund that owns very liquid securities. The smaller ETF may show fewer shares changing hands on a normal day, yet a professional liquidity provider can potentially source or hedge a larger trade by working in the underlying market. Conversely, a fund with visible ETF volume can still become more expensive to trade when the assets inside it are difficult to buy or sell.

The bid-ask spread is one of the clearest signals of current trading conditions. The bid is the highest displayed price a buyer is offering, while the ask is the lowest displayed price a seller will accept. A narrow spread usually means the market is competitive and trading friction is low at that moment, whereas a wide spread tells the investor that immediate execution carries a larger implicit cost.

Spread width also changes through time. Market volatility, uncertainty about the value of the holdings, reduced competition among liquidity providers and thin trading in the underlying assets can all make quotes wider. That is why an ETF that usually trades efficiently can temporarily become expensive to enter or exit without anything about its long-term investment objective having changed.

Who makes the ETF market work

ETF sponsors design funds, select indexes or active mandates, arrange portfolio management and handle the fund’s operating structure. Their job is not to guarantee a particular exchange price. They publish information investors use to understand the fund and, subject to the applicable rules and product structure, provide portfolio or other information that helps market participants evaluate the relationship between the shares and the assets behind them.

Authorized participants occupy a specialized position because they can transact directly with the fund in creation units. Their economic incentive is not to keep the ETF price at NAV as a public service. They participate when the difference between ETF shares and the underlying basket is large enough to justify the risks and costs of the transaction, which is why creation and redemption activity is best understood as a market mechanism rather than a guarantee.

Market makers and other trading firms provide quotes and compete for orders in the secondary market. Their willingness to quote tightly depends partly on how confidently they can value and hedge the ETF. A broad domestic equity ETF holding highly liquid stocks is comparatively easy to hedge, while a fund holding less liquid bonds, securities trading in another time zone or complex derivatives may require wider spreads to compensate the dealer for uncertainty and execution risk.

Exchanges, brokers and investors complete the picture. Exchanges provide venues and trading rules, brokers route customer orders, and investors supply the ultimate demand to own or sell ETF shares. The growth of online brokerage has made this secondary-market access routine, but the convenience of an order ticket does not erase the institutional market operating underneath it.

Why the ETF market has grown so large

The ETF market has expanded from a relatively narrow index product into a major part of U.S. investing. At year-end 2025, the United States had 4,495 index-based and actively managed ETFs, including commodity ETFs, with total net assets of $13.4 trillion. Those assets represented about 30 percent of the assets managed by U.S. investment companies, which shows how far ETFs have moved from being a specialized alternative to traditional funds.^[3]

Cost has contributed to that growth, particularly for broad index exposure where competition among large fund providers has pushed expense ratios down. The old article was right to recognize that ETFs can be inexpensive, but it attributed the result too heavily to market makers. Low costs arise from several factors, including passive portfolio management in many funds, scale, competition among sponsors, operational design and the fact that secondary-market investors trade with one another rather than forcing the portfolio manager to process every purchase and sale as an individual fund transaction.

Access has mattered just as much. Investors can buy ETFs in ordinary brokerage accounts and use them to reach broad stock indexes, bonds, sectors, international markets and many specialized strategies. That flexibility reduced the amount of capital and operational effort needed to assemble some exposures individually, and it also gave investors who already understood stock trading a familiar way to trade pooled investments.

The growth in ETF volumes has also encouraged more trading infrastructure around the largest products. More participants, tighter spreads and deeper order books can reinforce one another, especially in widely used broad-market ETFs. The feedback is not automatic for every new fund, however, which is why an ETF can exist in a rapidly expanding industry while still having modest assets, limited secondary-market volume or wider spreads.

The product range is broader than index tracking

Early ETF adoption was closely associated with index investing, and index funds remain central to the market. The modern ETF universe is much broader. Investors can choose actively managed equity and bond ETFs, factor and thematic funds, commodity-related products, option-based strategies, leveraged and inverse products, and other exchange-traded structures designed for very different purposes.

That variety requires more care with terminology. In ordinary conversation, people often use ETF as a broad label for products that trade on an exchange, but not every exchange-traded product has the same legal structure or risks. Exchange-traded notes are debt obligations rather than funds holding a portfolio of assets, and some commodity or currency products are organized under structures that differ from investment-company ETFs.

The same distinction applies when an ETF obtains exposure through derivatives. A fund using online futures, options or other contracts can produce a very different return pattern from a fund that simply owns a portfolio of stocks or bonds. Investors interested in currency exposure may also encounter products that relate to forex trading, but the economic exposure, legal structure and tax treatment can differ considerably from owning currencies directly.

Leveraged and inverse ETFs deserve particular attention because the market can make them easy to trade even when their return mechanics are easy to misunderstand. Many seek a multiple or inverse multiple of a benchmark for a single day, so compounding can cause performance over longer periods to diverge from a simple multiple of the benchmark’s cumulative return. High liquidity does not make a complex payoff simple, and ease of execution should never be confused with ease of analysis.

ETFs and mutual funds use different market mechanics

ETFs and mutual funds can both provide diversified portfolios, but investors interact with them differently. A conventional open-end mutual fund generally issues and redeems shares with investors at the fund’s next calculated NAV, typically once per business day. An ETF investor usually buys or sells existing shares in the secondary market at a market price that can change continuously during the trading session.

The difference alters where trading costs appear. Mutual-fund investors generally do not face a visible intraday bid-ask spread on the fund shares, although the fund itself bears portfolio transaction costs when it needs to trade securities. ETF investors see a spread directly when they buy or sell shares, yet much of the trading can occur between investors without requiring the ETF portfolio to transact at the same moment.

This structure also changes how liquidity is experienced. A mutual-fund shareholder expects the fund to process a redemption at NAV under its rules, while an ETF shareholder ordinarily sells in the market to another buyer or liquidity provider. The ETF route provides intraday price control and faster visibility, but the execution price depends on prevailing market conditions and may be above or below NAV.

Neither structure is automatically superior for every investor. A long-term investor making infrequent purchases may care more about portfolio exposure, expenses and taxes than intraday trading. Someone moving a large ETF position, trading a specialized product or operating in a volatile market should pay more attention to spreads, premiums, discounts and the liquidity of the holdings underneath the fund.

Market stress reveals the difference between tradability and value

One of the most useful features of an ETF is that it can continue producing market prices when the assets it owns are trading less actively. That does not necessarily mean the ETF price has become detached from reality. In some cases, the ETF market is incorporating new information faster than stale or infrequently updated prices in the underlying securities, so the apparent discount to NAV partly reflects the difficulty of measuring current portfolio value.

The same situation can look alarming to an investor who assumes NAV is always the unquestionably correct real-time price. NAV is a calculation based on the available values of the fund’s holdings, and those values are not equally fresh in every market. When bonds are trading sporadically or overseas exchanges are closed, the ETF may become one of the more active places where investors express a current view about the portfolio.

Stress still creates real risks. Wider spreads increase the cost of immediate execution, premiums and discounts can become larger, and market makers may reduce the size they are willing to quote. Investors who need to trade during those conditions face a different problem from investors who can wait for a more orderly market, so the ability to trade at any moment should be treated as optional liquidity rather than a requirement to use it.

What the ETF market means for individual investors

The ETF market gives individuals access to a trading and portfolio structure that once would have required far more capital or institutional infrastructure to reproduce. A single share can represent exposure to hundreds or thousands of securities, yet the investor can still choose when to buy or sell during the trading day. That combination is genuinely useful, especially for investors who want to control asset allocation themselves without assembling every underlying position.

Self-directed access also shifts responsibility toward the investor. The brokerage platform can execute an order, but it cannot determine whether the ETF’s strategy is suitable, whether the spread is unusually wide or whether two products with similar names carry very different risks. The old article treated self-direction mainly as a driver of ETF popularity, but it is equally important as a reason to understand the product before trading it.

The best way to use the ETF market is not necessarily to trade more often. For many investors, the market structure is most valuable because it combines diversified fund ownership with transparent, flexible execution. Active traders can make greater use of intraday pricing, short selling and tactical products, while long-term investors can largely ignore those capabilities and still benefit from competition, liquidity and access.

The market has room for both approaches because an ETF is a wrapper rather than a single investment strategy. What matters is the exposure inside the fund, the way the product obtains that exposure and the quality of the market in its shares. Once those pieces are separated, the size and popularity of ETFs become easier to understand: the structure is broad enough to serve very different investment objectives without requiring every investor to use it in the same way.