Thoughts about the markets, automated trading algorithms, artificial intelligence, and lots of other stuff

  • What Really Caused the Markets’ Melt-Down?

    Have you heard the commentators trying to explain Thursday's massive move down in the markets by blaming computer trading, a trader's error, or the news about what's happening in Greece?

    I don't believe that any of those explanations are the "cause" of the melt-down.

    100508 The Real Cause of the CrashThere's a difference between things that happen near the same time, and things that cause other things to happen. In statistics this is the difference between a coincident and a causal indicator.

    An Unlikely Explanation.

    Even if some trader accidentally tried to sell a billion shares of Procter & Gamble rather than 1 million shares … Do you really believe a broker's or exchange's risk-management protections would allow a billion share order (sure, an error … but not that error)? Or, do you really believe that a "fat-fingered" sale in America would cause Asia's market to go down 8%?

    Think about how many market participants there are around the world. Free market buying and selling is supposed to take care of mispriced assets. If
    something is too high, then people won't buy it. When something's too
    low, speculators swoop in to grab the bargain.

    A More Likely Scenario.

    The real story is that people are scared. And unlike the recent rally, the move down was met with selling rather than buying.

    There's an old trading adage that says markets climb a wall-of-worry one step at a time, then fall off the roof. In a normal up-trend, chances are you'll just hold what you own; because you have no real incentive to take action.  Consequently, as recent policies and actions pushed the markets higher, many market participants simply smiled and felt good about their good fortune.

    However, it doesn't work the same way when markets go down. In order to protect your profits, or avoid losses, it is important to take risk off the table. As more people start doing that, prices start to move faster, which feeds the fire … and finds even more sellers. As a result, there actually is an incentive to take massive action.

    But Don't You Have to Blame Someone?

    One of the interesting arguments that I've heard recently is that the crash was caused as high-frequency trading firms stopped trading in the market. In other words, the lack of liquidity caused these massive price moves.

    To me, it makes sense that high-frequency trading (or other algorithmic trading systems) stopped trading during times of market turmoil. One of the primary lessons from last year's bear market is to recognize that certain systems are designed only for normal market periods.

    As price and volatility move outside normal levels, we now tighten our risk and cash management parameters. Once we got past those limits, we stopped trading. Why? Because of the massive pain inflicted by not doing that the last time we saw those types of price moves and volatility.

    Likewise, I suspect it's the same for many other systems traders. Each of them went through a process of figuring out what works, and what doesn't work, during different market conditions. It makes sense that they learned to trade less when they don't have an edge.

    Consequently, the patterns of price movement and liquidity changed during the big move down.

    Let the Investigations Begin.

    Trying to figure-out what caused people to be afraid is silly. Fear
    cause people to be afraid. Human nature weighs the fight or flight
    instinct … and often chooses flight during dangerous situations.

    And if people are trying to sell, but no one is buying, then price
    will continue to fall until it's low enough that people feel they're
    getting a bargain again.

    On a side note, if a trader puts in a limit order to buy an asset if
    gets down to a certain price (let's say $0.01 for a share of Accenture)
    and there is no other buyer to fill a "market order", then crazy as it
    sounds, that is what happens.

    Will More Regulation Help Here?

    I see both sides.  On one hand, I am surprised that the Specialists weren't there to back-stop the market and take more sales at falling (yet, realistic) prices. Perhaps that merits some scrutiny?

    On the other hand, in a free market environment, do you really believe that it is in our best interests for the governments and the exchanges to figure-out how to prevent markets from going down?

    When the NYSE started to enforce trading curbs and slowdowns, sophisticated investors started off-loading some of their sales to other markets and exchanges around the world. The result is that prices continued to go down.

    Again, I don't believe that an error caused prices to go down, though it may have been in error in judgment caused by human nature for masses of the population to feel so scared.

    However, remember that fear and greed are the fuel that drives the engine of the markets.  I suspect that limiting fear will have unintended consequences.

    Reblog this post [with Zemanta]
  • Capitalogix Commentary for the Week of 05/10/10

    Well, that was something you don't see very often … a nearly 2000 point swing in the Dow.

    Here is what that looked like intra-day.

    100506 Tough Day in the Markets
    There has been unusual volatility for a while, but this was noteworthy. 

    A Weekly View of the S&P 500 Index Shows the Bigger Picture. 

    The recent rally stalled at a well-known Fibonacci retracement level.  In addition, it doesn't bode well for the bulls (at least in the short-term) that price just broke down through critical support, and on high volume.

    100509 SP500 Decision Zone

    When markets are ready to change course, we often see violent moves. The side that was enjoying the trend is fighting to keep it alive. The new side, taking over, will have nothing to do with that. Back-and-forth it goes … then all it takes is a massive move to spark a little fear and greed … and you saw what can happen.

    What Does the VIX Show?

    Here is a chart of the Volatility Index ("VIX") from Bespoke.

    100509 VIX Shows Fear Entered the Market

    Apparently, the VIX is not the only way to measure fear in the markets.  Another way is to follow what "insiders" do.  The idea is that if they believe the market will get stronger, then they hold their stock.

    So, What Does Insider Activity Tell Us?

    According to Trader's Narrative, insider selling continues to dominate buying by a wide margin. We’ve seen a continuously extreme reading from insider activity measures for the past 12 months. The market has – until recently – ignored this vote of "no-confidence" and plowed ahead. This sustained level of selling pressure by insiders is unprecedented in recent history. Usually we see the buy/sell ratio fluctuate between the two extremes.

    NYSE CEO Explains the Sell-Off.

    NYSE Euronext CEO, Duncan L. Niederauer, says his exchange slowed trades of stocks including 3M, Accenture and P&G during the 998 point drop.  So, you'll be happy to hear that it was a "feature" … not an "error".

    We are now pretty over-sold and due for a bounce. Throughout the recent rally, pull-backs triggered buying.  It would surprise me if that happened again here.

    Business Posts Moving the
    Markets
    that I Found Interesting This Week
    :

    • Questioning Whether the Recovery Can Be Sustained? (FTAlphaville)
    • Unpalatable Choices re Euro for Germany & European Central Bank.
      (WSJ)
    • Obama to Nominate Three to the Central Bank. (NYTimes)
    • Merger Will Cause Continental-Size Problems for American Airlines. (WSJ)
    • What Comes After Exhausting 99 Weeks of Unemployment Benefits. (LATimes)
    • More Posts
      Moving the Markets
      .

    Lighter Ideas and
    Fun Links

    that I Found Interesting This Week

    Reblog this post [with Zemanta]
  • Capitalogix Commentary for the Week of 05/10/10

    Well, that was something you don't see very often … a nearly 2000 point swing in the Dow.

    Here is what that looked like intra-day.

    100506 Tough Day in the Markets
    There has been unusual volatility for a while, but this was noteworthy. 

    A Weekly View of the S&P 500 Index Shows the Bigger Picture. 

    The recent rally stalled at a well-known Fibonacci retracement level.  In addition, it doesn't bode well for the bulls (at least in the short-term) that price just broke down through critical support, and on high volume.

    100509 SP500 Decision Zone

    When markets are ready to change course, we often see violent moves. The side that was enjoying the trend is fighting to keep it alive. The new side, taking over, will have nothing to do with that. Back-and-forth it goes … then all it takes is a massive move to spark a little fear and greed … and you saw what can happen.

    What Does the VIX Show?

    Here is a chart of the Volatility Index ("VIX") from Bespoke.

    100509 VIX Shows Fear Entered the Market

    Apparently, the VIX is not the only way to measure fear in the markets.  Another way is to follow what "insiders" do.  The idea is that if they believe the market will get stronger, then they hold their stock.

    So, What Does Insider Activity Tell Us?

    According to Trader's Narrative, insider selling continues to dominate buying by a wide margin. We’ve seen a continuously extreme reading from insider activity measures for the past 12 months. The market has – until recently – ignored this vote of "no-confidence" and plowed ahead. This sustained level of selling pressure by insiders is unprecedented in recent history. Usually we see the buy/sell ratio fluctuate between the two extremes.

    NYSE CEO Explains the Sell-Off.

    NYSE Euronext CEO, Duncan L. Niederauer, says his exchange slowed trades of stocks including 3M, Accenture and P&G during the 998 point drop.  So, you'll be happy to hear that it was a "feature" … not an "error".

    We are now pretty over-sold and due for a bounce. Throughout the recent rally, pull-backs triggered buying.  It would surprise me if that happened again here.

    Business Posts Moving the
    Markets
    that I Found Interesting This Week
    :

    • Questioning Whether the Recovery Can Be Sustained? (FTAlphaville)
    • Unpalatable Choices re Euro for Germany & European Central Bank.
      (WSJ)
    • Obama to Nominate Three to the Central Bank. (NYTimes)
    • Merger Will Cause Continental-Size Problems for American Airlines. (WSJ)
    • What Comes After Exhausting 99 Weeks of Unemployment Benefits. (LATimes)
    • More Posts
      Moving the Markets
      .

    Lighter Ideas and
    Fun Links

    that I Found Interesting This Week

    Reblog this post [with Zemanta]
  • Iron Man 2 is Good Mindless Fun

    100508 Iron Man 2 Image Have you seen it yet?  It is certainly generating some "buzz" and box-office traffic.

    My recommendation: let go of your expectations and simply enjoy the
    spectacle.

    Even Freud has to agree, sometimes a cigar is just a cigar … and sometimes, a movie is just a movie.

    Iron Man 2 was a fun and action-packed movie that I'm glad I watched on a big screen.

    Does It Live-Up to Its Hype?

    Before its release, there were a number of very negative reviews and predictions that it would be "unwatchable". Nonetheless, audiences are watching and, according to Rotten Tomatoes, enjoying the movie.

    I had fun seeing it with my son this weekend. It was good enough in virtually every way.

    The story held together well enough that I didn't think much about the plot (not that there was much of a plot to think about).

    The graphics didn't "wow" me, the way that Avatar's did; but they were good enough that I didn't think about them (even though many of the special effects had to have been computer-generated). 

    Here is a Trailer so you can see it for yourself.

    Here are more videos.

    Reblog this post [with Zemanta]
  • Iron Man 2 is Good Mindless Fun

    100508 Iron Man 2 Image Have you seen it yet?  It is certainly generating some "buzz" and box-office traffic.

    My recommendation: let go of your expectations and simply enjoy the
    spectacle.

    Even Freud has to agree, sometimes a cigar is just a cigar … and sometimes, a movie is just a movie.

    Iron Man 2 was a fun and action-packed movie that I'm glad I watched on a big screen.

    Does It Live-Up to Its Hype?

    Before its release, there were a number of very negative reviews and predictions that it would be "unwatchable". Nonetheless, audiences are watching and, according to Rotten Tomatoes, enjoying the movie.

    I had fun seeing it with my son this weekend. It was good enough in virtually every way.

    The story held together well enough that I didn't think much about the plot (not that there was much of a plot to think about).

    The graphics didn't "wow" me, the way that Avatar's did; but they were good enough that I didn't think about them (even though many of the special effects had to have been computer-generated). 

    Here is a Trailer so you can see it for yourself.

    Here are more videos.

    Reblog this post [with Zemanta]
  • The President, as Comedian-In-Chief

    Seal of the President of the United States

    President Obama was a hit at the annual White House Correspondents’ Dinner last week.

    Jay Leno was the
    headliner at the dinner, and Obama called him "the only person whose
    ratings fell more than mine."

    Leno observed that Obama was less aloof
    than he appears … "He loves to socialize … health care, car
    companies," naming industries where the Obama administration has
    intervened.

    The President got more laughs than Leno.  Perhaps part of that was in
    deference to positional power; however, give Obama some credit – he hired staff writers
    from The Daily Show to come up with his material.

    Reblog this post [with Zemanta]
  • The President, as Comedian-In-Chief

    Seal of the President of the United States

    President Obama was a hit at the annual White House Correspondents’ Dinner last week.

    Jay Leno was the
    headliner at the dinner, and Obama called him "the only person whose
    ratings fell more than mine."

    Leno observed that Obama was less aloof
    than he appears … "He loves to socialize … health care, car
    companies," naming industries where the Obama administration has
    intervened.

    The President got more laughs than Leno.  Perhaps part of that was in
    deference to positional power; however, give Obama some credit – he hired staff writers
    from The Daily Show to come up with his material.

    Reblog this post [with Zemanta]
  • This Sign of the Times May Say a Lot about the State of the Markets

    A friend was driving me to his office last week. A flashy car pulls up beside us at a stoplight, and motions for us to roll-down the window. Without even saying hello, this well-dressed man in his late-40s starts bragging about day-trades he made recently.

    SmartyHe asked my friend whether he bought the bank stock they talked about, and then went on to gloat about a few of his other successes, including buying Palm just before HP bought it.

    When the light turned, he said "you should have listened" and drove away.

    Little things can say a lot.  What do you think this implies about the
    state of the markets?

    I hadn't seen "that" type of behavior in several years.

    It reminded me of cocktail parties in the late 90s (up until about 2001). You know, where stock-picking gurus wearing black faux-turtlenecks and blazers drank expensive wine and talked about Internet stocks.

    Reblog this post [with Zemanta]
  • This Sign of the Times May Say a Lot about the State of the Markets

    A friend was driving me to his office last week. A flashy car pulls up beside us at a stoplight, and motions for us to roll-down the window. Without even saying hello, this well-dressed man in his late-40s starts bragging about day-trades he made recently.

    SmartyHe asked my friend whether he bought the bank stock they talked about, and then went on to gloat about a few of his other successes, including buying Palm just before HP bought it.

    When the light turned, he said "you should have listened" and drove away.

    Little things can say a lot.  What do you think this implies about the
    state of the markets?

    I hadn't seen "that" type of behavior in several years.

    It reminded me of cocktail parties in the late 90s (up until about 2001). You know, where stock-picking gurus wearing black faux-turtlenecks and blazers drank expensive wine and talked about Internet stocks.

    Reblog this post [with Zemanta]
  • Capitalogix Commentary for the Week of 05/03/10

    The rally finally ran into some resistance.  Still, the Dow Jones Industrial Average remains above 11,000.  However, the thing that caught my eye last week was that the Dow
    broke below its recent trend-line.  By itself, not a cause for major concern, just a key to notice.  The question is whether it can get back above that level, or will this be the start of a more meaningful correction?

    100503 Dow Under Its Trend-Line
    It is also worth noting that the MACD indicator is showing more downside momentum than it did at the same price level earlier in April.

    A Peek Over the Wall.

    Is
    China's Shanghai Index sending a warning about the world economy or just
    their economy?

    Unless things change in a hurry, China's Shanghai
    Composite could drop significantly.  This chart shows the triangle
    pattern that played-out over the past nine months.

    100502 
China Shanghai Index Break Down

    You can think of the Triangle as a well-contested battle
    between the bulls and the bears.  Inside the pattern, neither side
    gives-up much ground.  However, when one side loses conviction, the
    market  surges in the direction the winners push it. 

    Triangles
    are often continuation patterns.  So, be wary that this move is a
    head-fake down to trigger a big rally.  Otherwise, the target is pretty
    far below.

    Sentiment Here in the United States is Still Very Bullish.

    While stocks have certainly become more volatile in the last two weeks, newsletter writers seem to be taking it in stride.  According to Bespoke, the latest Investors Intelligence survey of newsletter writers  found that 54% of those surveyed are now bullish on the market.  The last time bullish sentiment was this high was back in December 2007, before the crash.

    100503 Investors Intelligence 042810

    Another important to measure of the crowd’s extreme bullish sentiment is that fewer than 20% of advisors are currently bearish. According to Prieur du Plessis, these are first indications of a market top.

    Another Sign of a Potential Top?

    The U.S. Treasury Department plans to sell “up to” 1.5 billion
    shares of Citigroup in the government’s
    biggest step yet to exit the 27 percent ownership of the bank it rescued
    during the financial crisis. Bloomberg quotes Geithner as saying: "We’re
    putting TARP
    out of its misery," and "the government is withdrawing from the
    financial industry after forcing lenders to recapitalize with private
    money."

    If you think that is funny, then so is this cartoon.

    100503 Uncle Sam the Day-Trader

    Business Posts Moving the
    Markets
    that I Found Interesting This Week
    :

    Lighter Ideas and
    Fun Links

    that I Found Interesting This Week

    Reblog this post [with Zemanta]