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ETF Liquidity - Facts v/s Myths 

Investing in an Exchange Traded Fund (ETF) provides liquidity through the secondary market trading and unit creation/redemption process. The liquidity of an ETF is primarily determined by the liquidity of the underlying basket of stocks, rather than the trading volume of the ETF itself. Here are some key factors to consider when evaluating ETF liquidity:1. Underlying stock liquidity: The primary source of ETF liquidity comes from the liquidity of the underlying stocks that make up the ETF's basket. If the stocks are highly liquid, the ETF will have better liquidity.2. Creation and redemption: The creation and redemption of ETF units by authorized participants (APs) can provide additional liquidity to the market. APs can buy or sell ETF units directly with the provider, without going through the market.3. Market maker activity: Broker-dealers acting as market makers can provide liquidity to the ETF market by buying and selling shares in the over-the-counter (OTC) market.4. Dark pools: Dark pools are private exchanges where broker-dealers can trade ETF shares with each other without revealing their positions to the public. While dark pools can provide liquidity, they can also lead to conflicts of interest and reduced transparency in the market.5. Investor demand: The demand for ETFs from individual investors can impact their liquidity. If many investors want to buy or sell an ETF, it can lead to larger trading volumes and increased liquidity.6. AUM: The AUM of an ETF can also affect its liquidity. Larger ETFs with more assets under management tend to have more liquidity, as they can provide more units for creation or redemption.7. Index fund basics: Index funds face challenges in running a successful index fund due to continuous subscription and redemption requests from investors. This can impact all existing investors and lead to tracking error.8. Algorithmic platforms: Algorithmic platforms can help manage individual risk appetite, strategy execution, and portfolio management for investors who want to use ETFs or index funds.9. Myth-busting: There are common myths surrounding ETF liquidity, such as the belief that ETF liquidity is solely determined by trading volume. However, the primary source of ETF liquidity comes from the underlying stocks' liquidity.10. Tax implications: The tax implications of ETFs and index funds can vary depending on the specific investment. It's important to consult a financial advisor or tax professional to understand the tax implications of these investments.In conclusion, evaluating ETF liquidity requires an understanding of the various sources of liquidity and their impact on individual investment goals. By considering these factors, investors can make informed decisions when building their portfolios.
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