Soldiers began crossing the border late on Sunday and pressed deep into south-western Somalia's Gedo region towards territory held by Islamist Shabaab insurgents.
"The Christian troops from Ethiopia are sending soldiers into Somalia, they have reached Gedo region now," said Sheikh Ibrahim Abu-Yusuf, a senior commander with the al-Qaeda linked fighters, warning the rebels would fight back.
"I tell you that mujahideen fighters are ready to defend their soil from the invading enemy," he told AFP.
Ethiopian soldiers rolled into neighbouring Somalia in November, but Prime Minster Meles Zenawi only admitted on Friday forces were fighting there, adding he would pull troops out "as soon as feasible."
Residents in Luq district in Gedo, close to the Ethiopian border, told AFP several hundred Ethiopians had marched into Somalia Monday.
"Hundreds of Ethiopian soldiers entered Luq in the night after crossing from the border town of Dolow, they have come with heavy machine guns and tanks," said Idris Moalim Abdualhi, an elder.
"I have counted at least 42 armed vehicles, including 28 tanks," said Ahmed Bashir, another resident of Luq.
"The convoy crossed from the border and entered the town, but they appear to be heading in the direction of Bay region," he added, referring to an area some 100km inside Somalia, held by the hardline Shabaab.
Before the arrival of the fresh troops on Monday it was estimated that Ethiopia had around 1 500 men in Somalia.
Armies from neighbouring countries are converging on the Shabaab. Kenya sent in troops and tanks into southern Somalia in October to fight the rebels it accuses of carrying out cross-border raids and kidnappings.
The African Union Mission in Somalia (Amisom) has some 10 000 troops - from Uganda, Burundi and Djibouti - in the Somali capital Mogadishu to protect the fragile Western-backed Somali government.
Ethiopia first deployed troops in Somalia in 2006 to oust an Islamist movement that ruled much of southern Somalia, but withdrew three years later after failing to stamp out the group.