SPY AND QQQQ LIQUIDITY PREMIUM

Click here for SPY chart

Click here for QQQQ chart

APPLICABLE TIME FRAME(S):  

SHORT TO INTERMEDIATE

UPDATE SCHEDULE:

Daily

REPORTING DELAYS:

None

EXPLANATION:

In times of great uncertainty, market participants tend to gravitate toward the vehicles that provide them the most liquidity.  For our purposes, we define liquidity simply as an instrument that allows the investor to get in and out quickly with minimal slippage. 

Over the past couple of years, exchange-traded funds such as SPY, which tracks the S&P 500, and QQQQ, which tracks the Nasdaq 100, have gained wide acceptance among both individual and institutional investors as trading vehicles with superior liquidity.  Instead of taking on the risk of perhaps not being able to get out of a position in a hurry without incurring significant slippage costs, these traders tend to instead place their bets with the ETFs, thereby allowing them to get out of the position in a hurry if the need arises.  These ETFs are also exempt from the "uptick" rule, so that they can be shorted on a downtick (unlike regular stocks).  They are also available for certain options strategies that stocks are not.

We tend to see volume become heavy in these ETFs when uncertainty about market direction is greatest, for the reasons outlined above.  Also, volume tends to wane when traders are feeling comfortable and decide to take on the risk of individual equities. 

To get a better handle on just how much uncertainty is out there, we compare the volume in these ETFs to the volume in the underlying stocks.  So, for the SPY Liquidity Premium, we compare the volume in SPY to the volume in the 500 stocks in the underlying S&P 500 index.  Similarly, for the QQQQ Liquidity Premium, we compare the volume in QQQQ to the volume in the 100 stocks in the underlying Nasdaq 100 index. 

When ETF volume is significantly different from that of the underlying stocks, we are often near a market turning point.

GUIDELINES:

Extremely high ETF volume, relative to the volume in the underlying stocks, is often a sign that uncertainty is very high.  When uncertainty is high, that usually means the market has declined significantly.  However, it is at market lows that uncertainty, fear, etc. reaches a peak, so it is no wonder that the Liquidity Premiums are often greatest near market lows. 

Conversely, when things are going well and traders are confident in the prospects of their stocks, they tend to see no need to trade ETFs.  It is at these points when the Liquidity Premiums shrink, and market peaks often soon follow.

STATS:

*Standard Deviation.

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