Volume is not the Best ETF Liquidity Indicator

Traditionally, it is common practice to utilize a combination of the average daily volume and the bid-ask spread to determine liquidity for a stock. However, a number of thinly traded ETFs are based on very liquid markets. Consequently, traders can execute large trades without distorting the ETF price. [ETF Liquidity, Trading and Market Making]

For example, BlackRock’s (NYSE: BLK) iShares unit points out that earlier this year one institutional investor was effectively able to make a purchase in the iShares Currency Hedged MSCI Germany ETF (NYSEArca: HEWG) that at the time represented 1020% of the fund’s average daily dollar volume and 1580% of the fund’s total assets. [A Refined Approach to ETFs]

Another issue to consider is volume correlations between two ETFs that track the same index. Hoffstein highlights the case of the SPDR S&P 500 ETF (NYSEArca: SPY) and the Vanguard 500 Index (NYSEArca: VOO), noting that “Normalizing volume levels in each ETF and computing daily correlations from January 2011 to October 2014, we get a mere 8.13% correlation. Not surprisingly, tracking daily percentage volume changes doesn’t provide a better result: the correlation of these changes is just 13.47%.   In other words, the volume in SPY has almost nothing to do with the volume in VOO – yet they both closely track the same index. So if volume is indicative, which ETF’s volume do we consider?”


ETF Trends editorial team contributed to this post.