Courtesy of John Spence
A surge in exchange traded fund trading this week signals that investors should buckle up for a volatile summer.
ETF trading soared to about 40% of overall volume on Thursday, one day after Federal Reserve Chairman Ben Bernanke said the Fed may soon begin tapering its purchases of $85 billion a month of Treasury bonds and mortgages. The Dow Jones industrial average plunged 354 points.
“My ETF-monitoring screens were lit up like a Christmas tree,” said Chris Hempstead, director of ETF execution at WallachBeth Capital, in a daily update Thursday. “Almost every ETF on my radar was trading at multiples of a normal day’s volume.”
He said it’s not uncommon to see a few ETFs have trading volume that high on a given day. But Thursday’s action “was something I have never seen before,” he said.
Volume in an unprecedented number of ETFs topped $1 billion for the session, he added.
The largest ETF, SPDR S&P 500, traded about 300 million shares, its highest one-day volume in more than a year.
Trading also surged in volatility-linked ETFs, such as iPath S&P 500 VIX Short-Term Futures ETN, which some traders use as short-term hedges, or to speculate on stock sell-offs.
“I’ve been tracking these metrics for more than four years, and I have never seen ETF volume this dominant in terms of dollar volume,” Hempstead said in an e-mail.
This week’s ETF trading spike highlights the investment products’ growing clout within financial markets. SPDR S&P 500 was the first U.S.-listed ETF, launching in 1993. The exchange traded product business has exploded to 1,464 offerings and nearly $1.5 billion of assets, according to XTF.com.
Traders, individual investors and financial advisers are increasingly using the low-cost ETFs, which are essentially mutual funds that trade like stocks, to buy entire market sectors rather than researching and purchasing individual stocks.
ETFs also allow investors to get exposure to entire asset classes such as commodities, bonds, currencies and foreign stocks with one trade in their brokerage account.
When ETF trading ratchets up, it often heralds more volatility.
“In times of distress, investors use ETFs for liquidity and the ability to shift quickly,” said Robert Trumbull, head of institutional ETF sales at State Street Global Advisors.
The 2008 financial crisis “showed the benefits of ETFs as institutions looked for liquidity,” he said.
When ETF trading volume soars, “a lot of it is people putting on trades to hedge bets. It’s not buy-and-hold,” Hempstead said.
If that’s the case, investors might want to prepare for an endless summer of volatility.