The Importance Of Trading Volume

So you identified an up trend in a sector/country ETF and reviewed the momentum figures in the StatSheet to select a suitable candidate for your investment portfolio. What else do you need to do before placing your order?

You need to check the average volume figures especially if you are investing larger sums of money. In my advisor practice, this is an important step and reader Bruce had this to say:

First, I found you website a couple of months ago and have been following it closely ever since.I find it an absolutely superb resource!

Quite frankly, I would use it as a stand-alone resource if not for one thing…you do not include volume, which I consider a vital component.

For instance, DBO may be marginally better than USO, but DBO only trades 72,900 ATV as opposed to USO which trades 10,603,700 ATV.

Liquidity is a paramount consideration, especially when you get stopped out or the slippage will kill you.

Would you consider adding average trading volume (ATV) to your spreadsheets?

Bruce pretty much follows the same steps as I do. If find two ETFs with very similar technical indicators, but with huge differences in volume, I will always select the one with the highest liquidity. While this may not be as important if your order is for only $10k, it can have an effect nonetheless.

I have found that low volume ETFs tend to have higher bid/ask spreads, which means that you don’t get the best fill when buying or selling along with additional slippage due to lack of liquidity. This is most prevalent on down days when everyone heads for the exit at the same time.

While the weekly StatSheet is already packed with all the information I can cram in, adding a volume column, while helpful, is just not possible. I personally simply review Yahoo’s financial site, which gives me quick access to the volume information in a few seconds.

Reader Bruce’s second question addresses another important area. Here’s what he said:

Second, what protocols do you use to get back into an ETF or fund once you have been stopped out?

For instance, last week I got stopped out of SLX. But steel is quite strong and has a viable thesis forinvestment. At 103.34, it is still 7.96% off its high of 112.28, and its “M-Index” has been cut in half from 18 to 9. Although the trend line has been broken, there is strong resistance at the 100-101 level. It looks like a buy at this level to me.

Thank you for your hard work and superior information.

While it certainly has merit, I personally don’t look at resistance points as this is too much of a subjective opinion. Besides, resistance points are made to be broken. While this approach may work in bull markets, I personally never had much faith in buying at resistance points or entering on dips. My preferred way has always been to buy on breakouts, which supports the basic law of physics that a body in motion tends to stay in motion.

SLX still sits above its long-term trend line (39-week SMA) by some +17%, which is quite high. My view is that if you were in that trade and got stopped out at a profit, be happy. This is a very volatile sector and a 10% sell stop may get triggered in a hurry even when used based on closing prices only.

However, if you are an aggressive investor, you could re-enter when SLX breaks out to new highs again, which would be an indication that the major trend has resumed. While that goes against conventional wisdom, trend tracking is all about buying on price breakouts and not about buying on pullbacks. It goes without saying that a disciplined exit strategy is a must.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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