Passive traders and ETFs...

Schweser SS16, LOS 44.j Schweser says that passive traders (like those used for index funds) favor limit orders. I would have thought that market orders would be more appropriate to ensure that execution occurs and the ETF replicates the index. If the ETF uses a limit order, execution is not guaranteed. Can anyone help me to understand this, cheers.

The CFAI mentions that passive traders’ first priority is cost thus they want to use limit orders. Anyway, the CFAI text mentions it in much more details and clarity. Let me know if you still have question after reading it.

Thank you elcfa Page 35, “passive traders…seek liquidity in their rebalancing decisions, but they are much more concerned with the cost of trading“. Page 37, “low cost trading is a strong motivation of passive traders“. I understand the carve out with respect to rebalancing decisions. However, i am curious, Is being “low cost“ a strong motivation, or a primary goal? To me i think replicating the index should be a primary goal, and secondly, seeking lowest cost execution…and not the other way around. Id be interested in your thoughts.

If you look at exhibit 8, it says that passive traders’ time horizon is days to weeks with motivation to rebalance portfolio (something to happen may be annually). The traders here are not concerned to match benchmark on a daily basis, but on annual basis, so they are not concerned whether they get traded today or tomorrow, but more to get the best deal and lowest cost.

Thanks elcfa…you are a star!