Why actively trade ETFs?

For those that might want more specific pointers on the AMEX website about XSH and other indicies ... here's how I came across the info:

A search of indexes available (this is where I noticed some HOLDRs specific indices):

http://www.amex.com/othProd/prodInf...erType=ListAll&hid_securityType=INDEX&choice=

Then for my XSH example/question I clicked on it's symbol.

The link is:

http://www.amex.com/othProd/prodInf/OpPiIndMain.jsp?Product_Symbol=XSH

There it tells you:

"Semiconductor HOLDRS Index
The Semiconductor HOLDRS Index (XSH) is an estimate of the per share value of the securities underlying one share of Semiconductor HOLDRS, which trade on The American Stock Exchange under the symbol SMH. The XSH Index is calculated based on the securities underlying a round lot of Semiconductor HOLDRS, adjusted to reflect the value for one share of SMH. The XSH Index originally included 20 companies that are involved in various aspects of the of the semiconductor business."

And finally click on the "components" link which is:

http://www.amex.com/othProd/prodInf/OpPiIndComp.jsp?Product_Symbol=XSH

- David

 

stop pushing web sites

 

Hi David,

After studying several of the sector indexes you mentioned, along with looking at time and sales prints and comparing exact fair values for some of the less liquid ETF indexes such as XUH, you are correct that there would indeed be a great benefit to watching the indexes for the HOLDRS in addition to just the primary index.

In particular, the benefit seems to be mostly with the less liquid HOLDRS and sector ETFs as opposed to the liquid ones. Thus, following $XUH.X to follow UTH (Utilities HOLDR) would be of much more benefit than using $XSH.X to follow SMH (Semiconductor HOLDR). This for the obvious reason that the spread is wider and volume is lighter on an ETF such as UTH. Since the index for the HOLDR prints even when no trades are going off on the ETF, following the index is a great way to know a more accurate "fair value" for the less liquid ETFs. In fact, I noticed that the prints on the sector indexes of each ETF were within pennies of the actual fair value of each ETF, even though the prints on the ETF may have been going off 10 cents above or below that figure.

Up until now, we have been using a spreadsheet that calculates the real-time fair value of each of the HOLDRS based on the precise underlying movement of the components of each HOLDR. This works great because it gives us an exact representation of what the fair value should be (including expense ratios) at any given time. However, if someone is not set up to allow Excel to link up directly with live quotes from their data provider, I see your idea as a great way for someone to follow the less liquid sector ETFs without using this spreadsheet technique.

Overall, I think there is a great benefit to watch BOTH the index for the sector ETF AND the regular index for the industry sector. In other words, if you are trading RTH (Retail HOLDRS), there is a benefit to watching both $IRH.X (Retail HOLDRS Index) AND $RLX.X (S&P Retail Index). The IRH is going to be a great representation of fair value of RTH pricing, while RLX is going to give you a better picture of the true strength or weakness of the industry sector as a whole because RLX is better diversified and weighted more equally than IRH (which is heavily concentrated on a few stocks). So, by watching both indexes, I think you indeed can look for hints of pending strength or weakness in the HOLDR and get a heads-up as to direction of the HOLDR. The link you posted in this thread is great for looking at all the indexes for the HOLDRS.

Great observation!

Deron

 

Market commentary on the broad-based and sector ETFs:

What a difference one week can make! At the beginning of last week, the S&P and Dow both set new lows of the year and were trading within striking range of their October 2002 lows. The Nasdaq, which had been showing relative strength to the S&P and Dow, was testing its lows of the year. However, less than five days later, all three indexes had rallied more than 10% off their lows, erasing nearly two months worth of losses. Once again, the Nasdaq showed the most relative strength and nearly rallied up to its prior high of the year, which was set in mid-January. Based on extensive technical analysis we shared with our subscribers in The Wagner Daily and ETF Real-Time Room, we were well positioned for the rally and realized profits of more than 7 points during the past week.
What caused the rally? Some would say it was a "war rally" in anticipation of the war finally getting underway, which removes the uncertainty that has been plaguing the markets. From a fundamental point of view, that was certainly a factor. However, the single biggest technical indicator that pointed to an impending rally was the sharp and sudden increase in total market volume that began on Wednesday, March 12. Although many new traders may forget to factor in the importance of volume when analyzing a trade, it is the single most important technical indicator (besides price) that you have at your disposal!

Unlike many technical indicators that only show what has already happened, volume is actually a leading indicator. With very rare exception, significant changes in volume nearly always lead to significant changes in price. While volume spikes in individual stocks can sometimes be misleading and based on factors that are not known to us, volume spikes in indexes and ETFs such as SPY, DIA, or QQQ do not lie. If volume significantly picks up in one of the broad-based ETFs, it clearly indicates an increased interest, either buying or selling, in the broad market. You are missing the "big picture" of what the market is trying to tell you if you fail to account for changes in volume when doing your daily technical analysis of the market.

To fully understand how volume affects price changes in the market, think of volume as the fuel that is necessary to make a fire burn. Without adding fuel, any fire will burn out within a short period of time. However, as long as fuel is present, the fire will continue burning. Want the fire to burn bigger and hotter? Add more fuel. If a rally is sparked but the volume remains light and does not increase proportionately, that is like cutting the fuel supply off from a fire -- the rally will quickly fade and "burn out." However, as long as volume is increasing, it will continue fueling the rally. The more volume increases, the longer the rally is likely to be sustained. To illustrate this example, take a look at the total market volume of the Nasdaq on the chart below compared with the price action of QQQ below it (both are daily charts):


Notice the correlation between increasing volume and the strong rally in the market? Your first clue was the volume spike on March 12, which provided you with plenty of time to enter long positions before the rally kicked into high gear on March 13 and March 17. Despite the geopolitical uncertainties, we took a calculated risk to take long positions over this past weekend based largely on the fact that volume was so strong in the latter half of last week. The volume was too high to only be a "short covering rally" and we knew that volume in an index rarely lies. Obviously, we were quite happy about being long over the weekend and netted 6 points of profit within the first two hours of trading on Monday.
The major indices:

Both DIA and SPY changed trends during the past week when the price patterns broke above the preceding swing highs (circled in purple). However, unlike SPY and DIA, QQQ was not recognized as making a trend change because it never set a new low first. We left the previous trendlines (the thinner trendlines) on the DIA and SPY charts so you can see how the trend changes have transpired during the past week. The green up arrows on the SPY and DIA charts point to the candlestick that broke above the trend change price level. The #1 on the QQQ chart indicates the price pattern has broken above the upper trend channel. MDY (S&P Mid-Cap Index) and IWM (Russell 2000 Small-cap Index) have yet to break above their prior swing highs. You may therefore conclude that the large caps are paving the way in this new ascending trend. However, until all the general markets are in sync with each other, a neutral stance is observed for broad market trend. Annotated charts of SPY, DIA and QQQ are below.

In addition to the daily chart of QQQ above, take a look at the weekly chart of QQQ below. You will notice that a VERY SIGNIFICANT event occurred this past week; we broke the upper channel resistance of a downtrend that has been in place for nearly two years, since May of 2001! Assuming the breakout above the weekly trendline holds, it could provide price support that could really give the Nasdaq a boost in the coming weeks/months:

Sector Notes:

The only sector that made the descending list for the week was OIH (Oil Service HOLDR). That's great, but I'm not sure it's reflected in the gas pump prices yet. A whole assortment of sectors shifted over to the ascending list, which can be located in the latest MTG Sector Trend Trigger List. Most notably are SMH (Semiconductor HOLDR) and HHH (Internet HOLDR), both making the first moves to the ascending list. If you look under the Trend Signal Date, you will see that SMH and HHH were on the ascending list a few days earlier than the other sectors.

We thought it would be nice to revisit a chart one of our subscribers brought to our attention last week. Below is a chart of UTH (Utilities HOLDR). Note the break above the swing high and resistance level above $60.29. The green up arrow indicates the date of the current candlestick, which is also the Trend Signal Date. The purple ellipse is the second anchor and marks the lower trend channel, as denoted by the bold blue ascending trendline. This is an example where the price pattern has moved above the swing high to cause the trend change rather than moving above the 2nd anchor to trigger the trend change. The 2nd anchor and swing high can also be the same price level, like with the broad-based ETFs above, but not in this case.

Closing Thoughts:

Chart analysis is like an art form. Ask ten analysts to find trendlines and support and resistance lines on a chart, and you'll get ten different annotations back. The analysis can be taught, but it takes practice to come up with an understandable picture that can be agreed upon by consensus. For trend analysis, it all comes down to locating the swing high and swing low and drawing out trend channels accordingly. At the same time, we can spot multiple retests of the price levels and locating support and resistance. What's truly great about the analysis is that it is applicable on any chart of any time frame. The MTG Sector Trend Trigger List does the analysis for you and works well to alert you to trade and invest on the "right side" of the market. From it stems low-risk trade opportunities in ETF sectors, which are inherently diversified, just like any sector mutual fund. The components and weights of each ETFs are adjusted periodically, (where changes are listed in AMEX), like managed mutual funds. Relative low risk and consistent returns are what Morpheus Trading Group strives for.

 

Deron,

Your last post had been a month ago.
'Sure get the impression you're like one of those people who once in a while hit the jackpot at the local casino and tell all their friends about it.
Unfortunately those same people quietly piss it all away and more hoping for their "volume breakout" technique.

 

While I can understand why you may think that, I have nothing whatsover to hide; just don't want to be one of those people who obnoxiously posts every day with nothing important to say. We have had very small losses for the past month, which were completely wiped out during the past four days.

 

.

 

I also wanted to mention that the trade stats I posted are based on a position model that assumes a $20,000 maximum capital exposure per simulataneous position. While I trade an account much larger than that, it is meant to be a more accurate representation of a typical account.

 

Here is an article I just completed on fixed-income ETF trading. I sent this article to our subscribers two weeks ago, but am also posting it here on ET for all you fellow ETF traders. In general, I trade the broad-based ETFs during trending market periods, while the sector-specific ETFs (HOLDRS and iShares) usually provide a better risk/reward on days when the broad market is choppy or in a sideways range. With the inception of the new fixed-income ETFs, I now have an additional tool in my trading arsenal that is an excellent vehicle for accomplishing several different trading objectives.

What is a fixed-income ETF?

Simply stated, a fixed-income ETF is an exchange traded fund that, rather than consisting of a group of underlying individual stocks, is comprised of various fixed-income instruments, most commonly bonds. This means you can now trade bonds on a short-term basis without the expense and complication that has prevented retail traders and investors from participating. In fact, placing an order to buy a group of bonds is now just as simple as placing an order to buy a stock, thanks to the new iShares® family of fixed-income ETFs from Barclay Global Investors. Let’s begin by discussing some of the benefits to trading the fixed-income ETFs.

Why trade fixed-income ETFs?

Although they were initially designed for long-term investors looking for easy access to investing in bonds, I have discovered the new Bond ETFs are excellent vehicles for short-term traders as well. While some of these ETFs may have too narrow of an intraday trading range to be easily traded on an intraday basis, they are excellent instruments to take a position in with the intention of holding for a few days or weeks. While the typical fixed-income ETF has an average daily range of only 10 – 50 cents, it will often move 1 – 2 points over the course of a week. Because they are less volatile than individual stocks, you could take a larger position size without significantly increasing your risk. As an example, I shorted both TLT (20-year T-bond ETF) and IEF (10-year T-bond ETF) as “swing trades” recently, held them for two days, and netted a handsome profit when the stock market rallied, which caused the price of the bond ETFs to go lower.

Do you think interest rates are going to go up? If so, you can profit from the rate increase by shorting one of the Government Treasury Bond ETFs, whose prices move inversely with their yields. Do you think that the price of bonds is due for a correction due to investors’ flight to safety over the past several years? If so, short one of the T-bond ETFs, set your stop, and sit on it.

Prior to the inception of the fixed-income ETFs, it was difficult for individual investors and traders to have easy access to bond prices as they do with stocks. This made it difficult to verify prices paid to your brokerage firm for individual bonds. Bond mutual funds, which the average investor or trader does have easy access to, are only priced once per day, at the close of trading. This creates a problem for the trader who wants to capitalize on an intraday move in bond prices. However, the new Treasury and Corporate Bond ETFs now provide you with easy access to real-time intraday pricing of various bond indexes and you have the ability to easily buy or sell them on intraday. By trading fixed-income ETFs, you now have access to intraday trading of Government Treasury and Corporate Bonds all with the same ease of placing an order to buy or sell a common ETF such as QQQ or SPY. While placing an order to buy individual bonds through your typical discount broker will cost you about $50 in commission, your commission fee for buying a fixed-income ETF is the same as what you normally pay for a stock trade, probably around $10.

Aside from short-term trading of these instruments, there are also many benefits to those of you who are looking to invest “longer-term” in the bond market. The biggest benefit for investors is that, unlike individual bonds, fixed-income ETFs provide diversification with just one trade and low minimum investments (you can trade as little as one share). The expense ratios are also much lower than those associated with a typical bond mutual fund, which is usually close to 1% annually, not to mention front-end loads.

Perhaps the greatest benefit of fixed-income ETFs for long-term investors is that they are an excellent tool for hedging stock or mutual fund positions in an IRA, 401k, or other retirement account. Since qualified retirement accounts cannot use margin, it is not possible to sell short any securities in an IRA. This creates a challenge if you are looking for a way to remain invested in equities, but also desire to reduce your risk. But with the inception of the new fixed-income ETFs, you could simply buy one of the Treasury Bond ETFs as a hedge against your equity positions. Since bond and stock prices typically (not always) have an inverse price relationship, the price of your Bond ETF will rise as the value of your equities drop.

If your personal assets are sensitive to interest rate fluctuations, you can also use the fixed-income ETFs to manage and hedge your interest rate risk. Remember that all ETFs can be purchased on margin and sold short (even on a downtick), meaning you can now use interest rate risk management strategies once available only to institutional investors. For example, fixed-income ETFs can be sold short to hedge interest rate fluctuations. In a rising interest rate environment, profits from a short position can offset some of the losses in a portfolio. All the fixed-income ETFs also pay regular dividends to shareholders, just like all the other ETFs.

Are they liquid?

When you first begin trading the various fixed-income ETFs, you may be falsely under the assumption that they are not liquid enough to be traded on a short-term basis. After all, each of the iShares trade an average daily volume of only 100,000 – 200,000 shares. However, don’t forget that each and every ETF, whether broad-based, sector-specific, or fixed-income, is a synthetic instrument. In other words, the market price of any ETF is not determined directly by supply and demand for shares of the ETF, but rather by supply and demand of the underlying composite of stocks or bonds. For example, even if not a single person is willing to buy or sell a single share of TLT, the bid and ask price will still move up and down throughout the day as the prices of the composite bonds changes. Therefore, getting your order quickly filled is as simple as entering a limit order, preferably in the middle of the spread.

What are my choices?

So, you’ve decided you would like to research and eventually start trading and/or investing in the fixed-income exchange traded funds. What are your options? As of now, there are two companies that have brought these instruments to the market. The first and most well-known family of fixed-income ETFs is the iShares, issued by Barclays Global Investors. iShares launched the first U.S. Treasury and corporate bond ETFs in July 2002 and today the four funds' assets total over $3.7 billion. The table below summarizes these:

TICKER DESCRIPTION

SHY iShares Lehman 1 – 3 Year Treasury Bond Fund
IEF iShares Lehman 7 – 10 Year Treasury Bond Fund
TLT iShares Lehman 20 + Year Treasury Bond Fund
LQD iShares Goldman Sachs InvesTop™ Corporate Bond
Fund

Below is a daily candlestick chart of TLT, one of the fixed-income ETFs I trade the most often. The chart gives you an idea of the volatility of the typical fixed-income ETF.



In addition to the four ETFs above, Barclays Global Investors has registered with the SEC to add a new fixed-income ETF, the CSFB Liquid U.S. Agency Bond Fund. It will consist of non-callable securities with remaining maturities of greater than one year from Federal Home Loan Banks (FHLB), Freddie Mac, and Fannie Mae.

You may also be interested to know that LQD, the GS Corporate Bond ETF, also trades options. Because LQD is currently priced at over $100 per share, this is a less expensive way to gain leverage through the same instrument. However, I do not recommend you trade options unless you already have prior experience doing so.

In November of 2002, a company named ETF Advisors launched a family of fixed-income Treasury Bond ETFs named the FITRs (pronounced “fighters”) designed to compete with the iShares, which were launched only several months prior. However, the FITRs never gained much popularity and are much less liquid than their iShares counterparts. As such, I do not trade the FITRs, but mention them to you for your information. There are four different FITRs, each of which are Treasury Bond Indexes: 1, 2, 5, and 10-year are your choices.

Summary

While the broad-based and sector-specific ETFs provide a lot of daily trading opportunities, the fixed-income ETFs bring us a whole new dimension of strategies that are ideal for both short-term traders and long-term investors.

To learn more about the fixed-income iShares, visit http://www.ishares.com or click here to go directly to the fixed-income section of the iShares web site. You can also visit the American Stock Exchange web site by going to http://www.amex.com for details on all ETFs, both securities and fixed-income.

 

Below is a summary of our analysis on the intermediate-term trend of the major broad-based ETFs we trade, as well as some observations on the various industry sectors. Just my 2 cents, for what it's worth. . .

SPY (S&P 500) broke through resistance of its weekly downtrend lines on Friday, which could serve as the stimulus for a decent rally from here. After spending most of the week in a sideways consolidation pattern that showed a good deal of intraday indecision, SPY closed the week above a 3-year downtrend line that has been in place since August 2000. The weekly chart of SPY below illustrates the break of this downtrend line, as well as the break above the 50-week moving average:



In addition to the break above the weekly downtrend line and 50-week moving average, the weekly ADX indicator closed higher this week, just above 20. This signals the start of a new uptrend. More importantly, the CCI indicator closed above 100, which confirms the strength of the new uptrend. This combination of the weekly ADX and CCI indicators has proven very reliable in the past, so it has definitely caught our attention, especially when combined with the break of a 3-year downtrend line. Volume analysis has been showing heavier volume on the buy side than sell side, indicating an overall positive advancing volume to declining volume ratio. Many technical signs point to higher prices from here, but keep an eye on the high of January 2003, which is a resistance level that SPY has not yet broken.

More importantly than the SPY breakout is the fact that DIA (Dow Jones Industrials) finally broke through its weekly trendline resistance as well. Since the Dow has been lagging both the S&P and Nasdaq during the uptrend of the past month, it was critical that the Dow confirmed the rally by breaking its weekly downtrend as well, which it did on Friday. In addition, DIA is now in the process of completing the follow-through of a bullish ascending triangle pattern. I have annotated both of these things on the weekly chart of DIA below:



The projected distance of a rally when an ascending triangle is broken is equal to the height of the triangle from the lowest low to the breakout point. Since the low of the ascending triangle was around 78.50 and the breakout was around 85.50, that equates to a projected rally of 7 points above the breakpoint. This gives us a target of approximately 92.50. However, it's more likely that the DIA rally would stop around 90.50, which is the high of December 2002. If you wanted to go long DIA, you could set your stop about 1 point below the breakout point (84.50 area). Based on a target of 90.50 and Friday's close of 85.81, this gives you a risk/reward ratio of more than 1:4 (risking about one point to gain over four points).

QQQ (Nasdaq 100) continues to be the leader of the three major broad-based ETFs. It broke its weekly downtrend line over a month ago and is the only of the three that is trading above its January 2003 high. However, now that SPY and DIA have broken key resistance levels, we expect to see sector rotation out of the Nasdaq and back into the S&P and Dow. In addition, QQQ will soon be running into resistance of its December 2002 high, which is only 61 cents above last week's closing price of 28.28. Therefore, we feel that long plays in SPY and DIA offer a better risk/reward than QQQ at this time. The daily chart of QQQ below shows the approaching resistance of the December 2 high:



Overall, the technical picture is starting to look pretty good out there. Rather than have an opinion on what the market is going to do in the coming months, we simply react and trade on the side of the market that the charts dictate. In the intermediate term, they point to the likelihood of higher prices, but a lot of overhead supply remains from last December. We feel it's a good risk to be long here, but, as always, keep your stops in place in case the breakout fails. TRADE WHAT YOU SEE, NOT WHAT YOU THINK!

Sector Notes:

Several industries made new highs last week, which led the indices to new highs as well. Retail, financial, software, and broadband aided in boosting the major indices and only two industries remain in our descending list, PPH (Pharmaceutical) and XLP (Consumer Staples), but both are nearing their trend change triggers.

The 20+ year T-bond (TLT) is weakening, signifying a break in the ascending trend line. This is not surprising given the extended rally that bonds have seen during the past year. We're considering taking a short position, with a multi-month time horizon, in a few of the bond ETFs.

Many of the international sectors are on fire! In fact, it's the kind of international support the U.S. needs in order to support a true bullish marketplace. For example, EWW (Mexico) is following in the footsteps of EWZ (Brazil), which has seen a very strong rally during the past month. The Asian ETFs are also looking better, partially due to the gradual easing of SARS fear. In fact, we are sitting on an unrealized gain of 5% on a long position we took in EWJ (Japan) on April 28.

Below is a daily chart of EWW (Mexico), which never looked back once it was identified as a new ascending trend on the April 21 issue of the MTG Sector Trend Trigger List:



Monthly Summary of ETF trades:

April was our most profitable month since the inception of Morpheus Trading Group. For trades closed during the calendar month of April, we netted a profit of 24.87 points from a total of 75 trades, which equates to an average of 3.5 trades per day. 60% of the trades were intraday trades, while the remaining 40% were held at least two days.

Total net profit for the month of April was $2,029. Based on size of the account on which the MTG Position Sizing Model is based, this equates to a net return on equity of 2.5% for the month of April. If 2:1 margin was used, the net profit for the month was 5.0%. Interestingly, a full 100% of the profits came from trades that were held at least two days (intraday trades were basically a scratch last month). Details of each trade that comprised our April results are available by clicking here.

Usual disclaimer applies. . .this is not meant to be trading advice, just my 2 cents. . .blah blah blah