The Mother of All Short Squeezes, from Victor Niederhoffer

September 19, 2008 |

This is similar to what happened to the H#nt brothers when they made money from buying silver and gold. Not only did they lose their gains,…

Nigel Davies adds:

It's difficult not to feel some sympathy for the shorts. The chess equivalent would be for the tournament director to take a look at your position and, on seeing your rooks poised to penetrate the opposing ranks, declare that for the next ten moves they could move only backwards.

Kim Zussman agrees:

Who wants to compete in games where the rules are unstable?

Victor Niederhoffer comments:

When the exchange rules on silver were suspended, the gold and silver markets ceased to exist for about eight years, especially in Chicago. I wonder if many people feel as Dr. Zussman does, and whether this will lead to a tremendous diminution of trading.

Sushil Kedia writes:

Sushil A short position, in general, turns out to be a postponement of purchases. Even though they are intended to be opened with an objective of purchasing lower, it is just a potential demand in the future; since buying may happen lower or higher out of a short position.

With short sales not existent or not allowed afresh this one key source of periodic demand into the future is absent. Such markets tend to go down with way more ease than those markets that do have an existing short interest. A large subset of emotive responses that can be forced into buying the dips or the squeezes is non-existent.

Likewise, a ban on short sales rather than solving the problem of weak markets only postpones the inevitable weakness into states where there are only herds of long only hands turned into sellers and no motivated buyers to step into the dips.

This perhaps can be studied, if data can be obtained, by comparing the downside swings during periods when short selling was not available and since when it has.

Kevin Depew sees another historical parallel:

Arthur "Bull" Cutten some 70-odd years ago was trotted out before the grain futures commission where he was declared guilty on six counts of "price manipulation." Same type of villification of short sellers occurred then too. I wrote about this in June during the "oil speculator" hearings because I found his declaration after the trial quite apt. I don't wish to self promote my article, the gist of it is this:

Some 70-odd years ago, the Grain Futures Commission declared that Cutten was guilty on six of the price manipulation counts he was charged with and ordered him suspended from all U.S. grain exchanges for two years. After the verdict Cutten declared, "What's the use of trading? The market doesn't move."

Comments

14 Comments so far

Matt Johnson on September 19, 2008 2:51 pm
Sympahty?!
These are the financial markets, we’re all big boys. No one is forcing us to play or go public.
This sympathy stuff is the feeling right before a bailout, like LTCM (I still can’t believe that move) - What happened to Lehman was a product of executive management and poor risk management - I say let them fall.
PS this squeeze is a great example of why speculators should use stops and keep betsize small…
Derf on September 19, 2008 3:53 pm
This week’s temporary 799+ company shorting limits were well-telegraphed. Supposedly, those in the know have already taken their short needs to short-ETF’s that use other mechanisms to the same end result.

Thus, the intent of the shorting limits has to be to help lubricate some of the overplenty sideline money back into the long stock arena. And to make the big fish large pool players take their traffic someplace more private (ie, so that it does not show up in ubiquitous and widely monitored “short interest” data bases.)

Sidenote. One wonders how many quant/algo shops just got their heads sliced off, assuming that their “engines” monitored short interest and cannot so readily monitor the instruments used by short ETF’s. Not to mention that their short trades are no longer allowed per se in the 799+ stock list.

Did this solve several problems for the present administration?:
(a) doing “something” about crashing stock prices, as in a Casablanca-esqe “rounding up of the usual suspects” by wink-wink nod-nod “authorities”, and
(b) redirecting the crowd needing shorting to officially sanctioned private providers.

Oy vey.
Rocky on September 19, 2008 4:10 pm
A slightly different spin:

It is unlawful in most states to purchase life insurance on an unrelated third party. It is also unlawful in most states to buy fire insurance on your neighbor’s house. The logic is that both of these actions are not in the “public interest.”

However, it has been perfectly lawful for a speculator to purchase a credit default swap on a company with which the speculator has no business relationship….and to then short the company stock aggressively.

Question: Is this analagous to buying fire insurance on your neighbor’s house?

Question: Should Victor’s limo driver be permitted to buy life insurance on Victor?
We Are...Penn State email list on September 19, 2008 5:42 pm
Matt Johnson: “This squeeze is a great example of why speculators should use stops and keep bet size small.”

My trading is based on finding quantifiable edges. Virtually all of them test better using no stops. Too often the market hunts down and kills your stop before it goes in your direction. (I am a former pit trader and thus a former professional stop-hunter.)

That being the case, the second part of your comment (keep bet size small) has real value.

I’m relatively certain these financial shenanigans will fail. James Grant once said, “All debt is paid, either by the borrower or the lender.” He left out the third option, taxpayers. If they raise taxes to pay for this massive bailout (5%-10% of GDP?), what’s left for the consumer to spend?

At least Franklin Raines, Jim Johnson, and Jamie Gorelick got rich!
George Parkanyi on September 19, 2008 7:14 pm
It’s always dangerous to go against any market that has politics arrayed against it. That’s why I didn’t worry too much about oil going higher than $150, because already in the low 100’s there was plenty of chatter from politicians about having to “do” something about it.

When things go wrong, the public wants a bad guy, and politicians pander to what the public wants if they think it will get them more votes without costing them anything. Hence speculators and short sellers are “evil”, and fair game to be targeted with rule changes. It’s not like there’s going to be a public outcry - heck, they’ll will want tickets to the lynching.

Caveat emptor - or perhaps venditor in this situation - to specs who don’t pay attention to the political winds.

Having said that, my system WAS loading up on short equity ETFs today. I have to go away and think about this …

Cheers,
George
david beard on September 19, 2008 8:12 pm
I visit this website on occasion, but have not commented until now.
This situation reminds me of a chapter in Reminiscences of a Stock Operator (1923), which I consider to this day the single best book on trading and investing. You may recall (and I may need to pull out my dog eared copy to get the facts straight) when our protagonist was swinging a large line of coffee from the short side, and the government declared coffee was a national security issue (meaning it was needed for the troops in WWI) and bought up the available supply, turning a large profit into a small loss. Nothing is new under the sun, especially on Wall Street.
DB
Matt Johnson on September 19, 2008 8:57 pm
Penn State:
Cool, I was a pit viper too. Early 90’s, comex. I a much better speculator than floor trader. Anyway,
I’ve tested a bunch too, so lets make this clear, a system that’s always in the market (long/short just for example), has a stop, it’s a reversal trade but there’s still an exit, or a stop loss. Now if you tell me you don’t trade a system like this, and you never use stop losses then I’m forced to believe you have 100% winners, since you never use a stop loss, and if this is the case, I promise you this, eventually one will get you. It’s the equivalent of picking up nickles in front of a steamroller, eventually you get caught. With all due respect to the author of this site, Vic knows what I’m talking about. IMO the only thing worse than not using stops is averaging losers. I’m not trying to pick a fight, but argue this till the cows come home. Traders who don’t use stops are black swans waiting to happen.

Matt
Matt Johnson on September 19, 2008 9:03 pm
Hey Kevin, Nice article, thanks for sharing. Do you know any books written about Cutten? I've searched and searched over the years, but I've never found anything. I'm going to look up the Time mag you reference. Cheers, Matt
George Parkanyi on September 19, 2008 10:26 pm
Hi Matt,

My system averages losers by definition. I never use stops. I don’t let my profits run enough.

But it hasn’t been all that bad. Kinda depends on what you’re averaging - and how.

Cheers,
George
David Whitesel on September 20, 2008 10:18 am
Sushil K posits; Likewise, a ban on short sales rather than solving the problem of weak markets only postpones the inevitable weakness into states where there are only herds of long only hands turned into sellers and no motivated buyers to step into the dips.

This perhaps can be studied, if data can be obtained, by comparing the downside swings during periods when short selling was not available and since when it has.

Me thinks that there is too much missing information in your thoughts. What we are coming to know is that up to 1.2 trillion naked shorts have been identified. I presume you do understand that those shares are counterfeit, and they are outside the reported soi data?

I’ve maintained a daily log of 44 companies with another 60 or so intermitently debugged. In the course of this examination, by way of counting, news began appearing in 2006 that the output from the mouthpieces of Wall Streets sensory organs had sprung many leaks. I would advise everyone to visit Dr Byrnes site and assess for yourself. My view is that certain systemics will be changed, because the debugging of the systems sensory organs have outted and properly characterized illegal activity, by debugging the output of the systems sensory organs…….the mechanisms used in routine obfuscation are now broken. Things are going to change………the line forming at the window, seeking exemption from prosecution, will be very long very soon.
rumor has it……FIFO will be the protocall used in adminstration.

Dr Byrnes site uses RO/RS=CF better than anyone ever before and this forensic approach, is a deal breaker for those so entangled..
http://www.deepcapture.com/
David Whitesel on September 20, 2008 10:35 am
To be fair this defines what is on the table.

RO/RS = CF is as important to Social Systems as E=MC2 is to Science. The Market is a Social System.

We can know a thing by its character, and its character is defined by its Sensory organs. The description below nails down what to look for, and leads the seeker to a place where proper characterization can be made. Logic is the art of non contradictory identification.
As an aid to measuring social systems performance, and thereby elevate our social systems, we set about correcting contradictions both real and contrived by iteration. We add the tool described here, known as Locard’s Exchange Principle http://siliconinvestor.advfn.com/readmsg.aspx?msgid=24345914
use it wisely, because it contains truths of self evidence.

Corollary #1
All systems are only as good as their sensory Organs.
A System is no Better than its sensory organs
Corollary #2
To those within a system, outside reality tends to pale and disappear;

In an effort to introduce quantitative methodology into this important area of research a group of dedicated systemologists has paid particular attention to the amount of information that reaches, or fails to reach the relevant systems administrators also classified as Control Units (CU) of any particular system.

The crucial variable they have found is the fraction Ro/Rs where Ro equals the amount of reality which fails to reach the control unit. And Rs equals the total amount of reality presented to the system.

The fraction Ro/Rs varies from 0 (full awareness of outside reality) to unity ( no reality getting through) The result is known naturally enough, as the COEFFICIENT OF FICTION (CF)
Ro/Rs=CF
Joe Davis on September 21, 2008 12:36 am
There seems to be no shortage of sympathy for shorts, high praise for the wonders of shorting, and disdain for any attempt to stem the brutal and “price insensitive” selling raids.

But very little is said about the peculiar and panicked high volume selling of any name with supposed negative news.

That Thursday afternoon flush of so many financials had the look of massive and concerted dumping at any price. It wasn’t grandma.

Whether this was natural or manufactured, from the CDS market , bond or other hedgers, it has the effect of forcing legitimate stock owners OUT of their positions. At some point it is your fiduciary duty to say uncle. They say don’t fight the market, well, if the market is going to zero, you sell. No one wants to baghold the next LEH.

I think the market can function just fine without unlimited and unhampered short sales. Where shorting was really needed was the pumped up and tape painted HOUSING market that just got us into this mess.
Matt Johnson on September 21, 2008 12:37 am
Hi George,
Wow.
“My system averages losers by definition. I never use stops. I don’t let my profits run enough.
But it hasn’t been all that bad. Kinda depends on what you’re averaging - and how.”

My only answer is luck, that’s how.
Averaging losers by definition is deadly, just like never using stops (so you must have 100% winners - and I don’t know how this can be true). No one ever lets their winners run enough, just like you can’t be too heavy on a winner.
Eric Blumenschein on September 21, 2008 3:30 pm
If you want to short, move to the futures. No restrictions there.

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