One of the most persistent myths about exchange-traded funds is that a low daily trading volume figure on a broker's screen means the fund is illiquid, hard to sell, or somehow risky. For UK investors comparing ETFs before buying, this misunderstanding can lead to overlooking perfectly sound funds simply because they look "thinly traded" compared with a giant tracker that changes hands millions of times a day. Understanding how ETF liquidity actually works — and why it is fundamentally different from the liquidity of an individual share — helps investors judge trading costs and execution risk far more accurately.
What "liquidity" means for an ETF
Liquidity, in simple terms, describes how easily an asset can be bought or sold without materially moving its price. For an ordinary company share, liquidity is closely tied to how many shares are outstanding and how often existing holders choose to trade them. If very few people want to trade a small company's stock on a given day, the share can genuinely become difficult to deal in at a fair price.
An ETF is different because it is not a fixed pool of pre-existing units changing hands between investors. It is an open-ended structure with a mechanism for creating and redeeming units on demand, which means the liquidity an investor experiences is really a combination of two layers.
The two layers of ETF liquidity
- Secondary market liquidity — the buying and selling of existing ETF shares between investors on the stock exchange, which is what a trading volume figure captures.
- Primary market liquidity — the ability of authorised participants and market makers to create new ETF units or redeem existing ones directly with the fund provider, in exchange for the underlying basket of assets (or cash).
Published daily volume only reflects the first layer. The second layer, which operates largely behind the scenes, is often the more important one — and it explains why an ETF that appears to trade rarely can still be dealt in efficiently and in size.
The role of market makers and authorised participants
Every ETF has one or more designated market makers who are contractually obligated, under the rules of the exchange it is listed on, to provide continuous buy and sell quotes throughout the trading day. These market makers do not simply sit on a pile of ETF shares and wait for buyers; they actively manage their exposure by trading the underlying securities the ETF holds.
If an investor wants to buy a large quantity of an ETF that rarely trades, a market maker can, in effect, manufacture new shares. It does this by buying the underlying basket of shares or bonds the ETF tracks (or a close proxy, using a hedge in the interim) and delivering new ETF units created through the primary market process, known as "creation". Conversely, if an investor wants to sell a large block, the market maker can accept it and later redeem it back to the fund provider for the underlying assets, a process called "redemption".
Why this matters in practice
The practical consequence is that the true liquidity of an ETF is closely linked to the liquidity of what it holds, not to how many times its own shares have traded that day. A UK-listed ETF tracking the S&P 500 or the FTSE 100, for example, can typically be traded in large size with a tight spread even on a day when the exchange screen shows modest volume, because the underlying constituent shares are among the most liquid instruments in the world.
By contrast, an ETF tracking a narrower or less liquid market — smaller emerging market bonds, for instance — may show a healthy daily volume figure but still be more expensive to trade in large size, because creating or redeeming units ultimately requires dealing in a less liquid underlying market.
Reading the signals that actually matter
Rather than fixating on trading volume, several other indicators give a more accurate picture of an ETF's real liquidity.
The bid-offer spread
The gap between the price at which an investor can sell (the bid) and the price at which they can buy (the offer) is one of the clearest real-time signals of trading cost. A consistently tight spread, even on a fund with modest volume, generally indicates that market makers are comfortable quoting close prices because the underlying assets are easy to source or offload.
The liquidity of the underlying index
Investors can ask a simple question: how easily could the assets inside this index be bought or sold today? A global developed-market equity tracker draws on some of the deepest, most liquid markets in existence. A fund tracking small, illiquid corporate bonds or frontier market equities draws on a much shallower pool, regardless of how the ETF itself has traded historically.
Fund size and provider scale
While not a perfect proxy, a fund with a reasonable level of assets under management from an established provider tends to attract more active market-making interest, which can support tighter spreads over time.
A worked example
Suppose an investor is comparing two ETFs. Fund A tracks a well-known global developed-markets index and shows average daily trading volume of only a few hundred thousand pounds — modest compared with the largest funds on the market. Fund B tracks the same broad index but is one of the largest and most heavily traded ETFs available, with tens of millions of pounds changing hands daily.
On the surface, Fund B might look like the obviously "safer" or more liquid choice. But because both funds hold the same highly liquid global equities underneath, a market maker can create or redeem units in either fund efficiently by trading those underlying shares. In practice, an investor buying a typical retail-sized position — say £10,000 — is likely to find similarly tight spreads on both funds, because the constraint is the liquidity of the underlying index, not the ETF's own trading history. The headline volume difference mostly reflects how popular each fund happens to be with other investors, not how hard either would be to trade.
This example is illustrative only and not a comparison of any specific named products; the general principle — that underlying liquidity, not headline volume, drives tradability — holds broadly across the market.
When low apparent liquidity genuinely is a warning sign
None of this means trading volume is meaningless. There are situations where thin apparent liquidity does reflect a real underlying issue.
| Situation | Why it matters |
|---|---|
| Very small, niche ETF with few market makers registered | Fewer participants providing quotes can mean wider spreads and less price competition, especially in stressed markets. |
| ETF tracking genuinely illiquid or opaque underlying assets | If the underlying basket itself is hard to price or trade, the primary market mechanism becomes less efficient, and spreads can widen sharply during volatility. |
| Very wide, erratic bid-offer spreads | A spread that moves around a lot, or is consistently wide relative to peers, is a more reliable red flag than volume alone. |
| Fund provider considering closure | If assets under management fall very low, some providers may eventually wind up a fund, which is a business risk distinct from day-to-day liquidity. |
Practical steps when assessing an ETF's liquidity
- Look past the daily volume figure and consider what the fund actually holds underneath.
- Check the typical bid-offer spread, ideally at different times of day, rather than relying on a single snapshot.
- Consider using a limit order rather than a market order for larger trades, particularly outside of the underlying market's core trading hours, to avoid an unfavourable price during quieter periods.
- Be cautious about trading UK-listed ETFs that reference US markets very early or very late in the UK trading day, when the underlying market may be closed and spreads can widen as a result.
- For very large trades, some platforms and brokers can request a quote directly from a market maker, which may achieve a better price than routing through the public order book.
Timing trades around underlying market hours
A related and often overlooked point is that an ETF's liquidity is also linked to whether the market it tracks is actually open. A UK-listed ETF tracking US shares can technically be traded throughout the London trading day, but if it is traded before US markets open, market makers have to price it based on estimates and hedges rather than live, direct access to the underlying shares. This can widen spreads noticeably during the early part of the London session for US-focused funds, even though the fund's average daily volume looks perfectly healthy over the full day.
How this differs from liquidity in a traditional open-ended fund
It is also worth contrasting ETF liquidity with that of a traditional open-ended fund, such as a unit trust or OEIC, which many UK investors already hold in an ISA or pension. Those funds are typically dealt once a day at a single valuation point, with the fund manager creating or cancelling units directly in response to investor demand, and no separate secondary market or bid-offer spread for the investor to navigate. ETFs, by trading continuously on an exchange throughout the day, offer more flexibility over timing, but that flexibility comes with the added complexity of spreads and order types described above. Neither structure is inherently superior from a liquidity standpoint; they simply distribute the mechanics of buying and selling differently, and understanding which mechanism applies to a given holding helps investors interpret what they are actually seeing on their platform's dealing screen.
Key takeaways
- An ETF's daily trading volume on the exchange reflects only secondary market activity between existing investors, not its true capacity to be traded.
- Market makers can create or redeem ETF units directly with the provider, meaning real liquidity is closely tied to the liquidity of the fund's underlying holdings.
- An ETF tracking a highly liquid, well-known index can often be traded efficiently in size even when its own headline volume looks modest.
- The bid-offer spread and the liquidity of the underlying assets are generally more useful indicators than volume alone.
- Genuine liquidity risk is more likely in niche funds tracking illiquid or opaque underlying markets, or where spreads are wide and erratic.
- Using limit orders and trading when the relevant underlying market is open can help investors achieve fairer prices, particularly for larger deals.