How do underlying stock pivots relate to IWM pivots?

[mklein9]

Sorry if this isn't appropriate for this forum. I have been wondering for a while about pivots and have spent some time studying IWM pivots and the price action near them as Billy has described. I can understand how floor trader have some rules of thumb about levels that they target and watch, and it makes sense.

Floor traders (I assume, since I don't know any personally) operate by trading specific securities. One can't trade "an index" but one can trade IWM, for example. However, IWM actually consists of some number of underlying stocks, more or less mirroring the RUT index. Each of those stocks has a market maker and the floor trading activities, I presume, progress along similar rules as Billy has described for pivots. Then, there are also floor traders who trade IWM. When IWM trades, trades are created for the underlying stocks as well.

Thinking about how pivots enter into the picture for IWM, I am not seeing the connection between all these players. Each underlying stock's floor traders might be targeting certain pivot levels for his/her stock. And the IWM floor trader may do that for IWM as well. But these pivots don't match each other. Do the underlying stocks' pivots drive IWM prices? Or vice versa?

As far as I can tell, there is no way to just sort of "add up" the underlying stocks' pivot levels and hope in any way to match IWM's own pivot levels. So it appears to me that there is a lot of fighting of stock levels going on. Which leads me to ask, does the trading in IWM maybe overwhelm trading in the underlying stocks? If so then IWM's pivots might dominate. If not, what do IWM pivot levels mean?

To try to answer this question I looked at the top 20 components of the RUT index with their weightings (this info isn't available for IWM that I could find). I then calculated their average daily dollar volume and compared it with the dollar volume that would come from IWM trading (which is about $5 billion/day). The ratios vary widely. One stock, IDCC, has only about 8% of its volume coming from IWM trading. Most others vary from maybe 30% to 60%. One is almost 90%.

Now I presume that IWM is composed of the most liquid of RUT stocks so that IWM doesn't represent the majority of their volume. Although that's an assumption, if we take it as true, then IWM volume may represent maybe 20-50% of the underlying stocks' volume. That's substantial but by no means dominant.

So I'm still left with the question, what is the relevance of IWM's pivot levels? The underlying stocks' floor traders work with their stocks' pivot levels individually, but that does not appear to translate to specific action at specific IWM pivot levels. And trading IWM pivots would appear to not translate to the underlying stocks' pivots. To my thinking, the only way IWM pivot levels could be relevant is if IWM were so dominant that its underlying stocks' volumes had virtually no impact, which, at least for the top 20 RUT stocks, is not the case (except for one). Furthermore IWM probably discards stocks where it is the dominant source of trading volume (as a guess).

Maybe there is an obvious thing I've overlooked, which is quite likely as I'm quite the noob here.

Thanks,

-Mike

[Billy]

Mike, this is an extensive question requiring an extensive answer that I will try to provide later.

But you have many misconceptions. Here are some preliminary remarks:

-IWM is EXACTLY made up and weighted like the +/- 2,000 stocks of RUT, just like QQQ is for the 100 Nasdaq stocks or SPY for the SP-500. You can find all IWM holdings here: http://us.ishares.com/product_info/fund/overview/IWM.htm

- Most Small cap stocks are not liquid enough to provide multi-pivots confluences reliability. Market makers use other techniques for their inventory management. So, the individual stocks pivots are independent of IWM's pivots.

- The aggregate multi-pivots on an index (IWM, SPY, QQQ, DIA) reflect exactly the " aggregate" market" equilibriums, supports, resistances and imbalances. Index (and ETF) traders play the market and don't care about individual components so much. Historically, the majority of the stocks will be extended into IWM's resistances and pressured into IWM's supports. So, it is more the individual stocks that are adapting to IWM's floor levels than the reverse. Each stock will tend on average to react to IWM's floor levels according to its own volatility and relative strength.

I will continue later,

Billy

[mklein9]

Thanks, Billy, I expect this is not too easy a question, and I have no doubt that I have many misconceptions :-).

Regarding IWM holdings, they are not exactly the underlying Russell 2000, at least according to IWM's prospectus which says:

"BFA uses a representative sampling indexing strategy to manage the Fund. "Representative sampling" is an indexing strategy that involves investing in a representative sample of securities that collectively has an investment profile similar to the Underlying index... The Fund may or may not hold all of the securities in the Underlying Index."

This distinction may not be of any consequence.

-Mike