Here at The FRED Report ( www.thefredreport.com), we analyze ETFs  (Exchange Traded Funds) rather than indices, and in recent days, some of our clients have asked us why we do this. The reason is that ETFs are actually traded, while Indices simply measure. Another benefit is that we are independent unlike some of the NYSE firms that do not allow research analysts to comment on ETFs for compliance reasons. Two areas of Technical Market Analysis where Index vs. ETF analysis becomes important are gaps and volume. First, we will examine gaps.

GAPS

Let's look at some charts of ETFs vs. their respective indices. Below, we show the SPDR S&P 500 ETF (SPY), an ETF that mimics the performance of the S&P 500, and the S&P 500 Index (SPX.X). Notice that the SPY had a gap open two days ago, while the SPX did not. The reason for this is that most quote systems simply use yesterday's CLOSE as today's OPEN. From a technical analysis perspective, analyzing the index can create distortion.  The index is showing trades occurred in an area where in fact no actual market trading took place.

 

This is also apparent when looking at the Mid Cap and Small Cap indices vs. the most active ETFs measuring those indices. We show charts of the S&P 400 Mid Cap (^MID) vs. the MidCap SPDR Trust (MDY), and the S&P 600 Small Cap (^SML) vs. the iShares SP Small Cap 600 (IJR).

 

This is even clearer on the S&P 100 Index (^OEX) and the iShares S&P 100 Index ETF (OEF). There are two instances I will point out. The first is the downside gap on June 28, 29, and the second is the upside gap on July 12, 13.

 

Can this also happen in Sectors? You bet! Let's look at the AMEX Oil Index (XOI) vs. the Energy Select Sector SPDR (XLE). There are many examples, but the most graphic one is the volatility experienced around the trading of May 7 and May 10. Note the gap on the XLE, and the lack of such a gap on the XOI.

 

Gaps are important to the market analyst as they can connote exhaustion as the last bit of buying or selling in an extended move occurs or acceleration. Often gaps are filled, which simply means that the market trades into the area of the gap later on.

VOLUME

Now, let's look at volume. A quick look at daily volume from Yahoo Finance's Historical Prices for the SPX (S&P 500 Index) and the OEX (S&P 100 Index) shows that both of these indices volume values are the same. How can this be true? The answer is: it is NOT true!  Total market volume is given for both indices. Now, compare volume on the SPY vs. volume on the OEF. You can see some big differences. This is also apparent in our sector examples -- the volume on the XOI is different, but not much different than the XLE. Since, by definition the XOI cannot be traded, just what does that volume number represent? We are not sure.

We hope that this clarifies why at The Fred Report we use ETFs in our analysis of market behavior. They provide more accurate trading history and volume statistics, which enable us to better judge supply and demand. We believe this gives our subscribers an edge over other services that only analyze the indexes themselves. Disclaimer:

This article does not constitute a solicitation or offer to buy or sell securities. Interested parties are advised to contact the entity with which they deal if they desire further information. No representation is being made that the information herein is accurate or complete. Any opinions or estimates contained in this communication represent the judgment of Fredco Holdings, Inc. at this time and are subject to change without notice. Fredco Holdings, Inc, its employees, officers, directors, principals, agents, affiliates or advisers may from time to time provide recommendations with respect to, acquire, short sell, hold or sell a position in, the securities or instruments named or described in any report or information being provided herein, provided however that no buying or selling activity will be taken with respect to a security referenced in a report by such parties within three days of such report's publication. The information contained herein was prepared by The FRED Report, which is solely responsible for the contents of this report. Although Fred Meissner, Jr. is a registered representative of Lamon & Stern, Inc., neither Lamon & Stern nor any of its principals, officers, affiliates, agents or employees is in any way responsible for the contents of this message.

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Fred Meissner is founder and publisher of The Fred Report. Fred is a CMT and past President of the Market Technicians Association (MTA). He recently left Merrill Lynch's Market Analysis Department and Sector Strategy Department to form The Fred Report.  A detailed bio is here:Fred Meissner.