ETF volume analysis

By David Vomund
As the markets bounced back in 2009, investors poured money into exchange-traded funds (ETFs), which held a record $776 billion domestically at the end of the year. ETFs are popular trading tools among technical analysts, because they offer access to market indices, sectors, countries, commodities, and leverage.

However, although ETFs trade like stocks, they aren’t individual equities, so technicians must be careful when analyzing them. Indicators that work with individual stocks may not work with equity ETFs. Specifically, volume analysis is less reliable on ETFs, unless adjustments are made. Instead of analyzing an ETF’s volume, traders should focus on the volume of its largest underlying stock holdings.

Pump up the volume
Figure 1 shows a daily chart of the iShares Pharmaceuticals ETF (IHE) and its volume below it. The bottom panel shows the combined daily volume of IHE’s 10 largest stock holdings, representing 62 percent of the ETF’s total portfolio. 



There’s a dramatic difference between volume of the ETF and its top holdings. First, IHE volume spiked sharply in early May 2009, implying a very important trading day (point A). However, no such spike occurred in the volume of its largest stocks. Similarly, volume spiked twice in IHE in early August (down arrows), but its component stocks posted below-average volume on those days.

The opposite scenario — when an ETF’s top holding generates heavy volume while the fund is thinly traded — can also create confusion. In mid-October, IHE’s component stocks posted a series of high-volume days (point B), but the ETF had average volume, with the exception of one day, during the same period.

For the complete article, see the April 2010 issue of Active Trader magazine. Click here to subscribe.



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