May

18

a quizOne may inquire in answer to Rocky's quiz to what pockets do the big v shaped moves big down and big up in a half hour accrue. One would not think that it would accrue to those who are leveraged more than 2 to 1 or 3 to 1, as not only must they meet initial margin but must meet maintenance margin before they are liquidated at the lows would not the ability to borrow from a big lender at low rates help the top feeders and flexions in such a regime? Just a theoretical query.

George Parkanyi asks:

Why not? You could target multiple stocks, some of which are just decoys to mask the main attack, work it from multiple accounts, have your "one cent" bids at the ready, and then bring the hammer down with a concentrated attack at exactly the place where most traders would place stop-losses. Enough kindling to spark a sudden flash fire. You slam the market down to the low bids placed that have been placed according to some pre-calculated algorithms that make it look random (which you've probably modeled already on a Cray). You cover with a huge profit. Others step in, it's all over, and you slink away. You would need to have detailed knowledge of how off-exchange platforms work (e.g. no stock-specific circuit-breakers). Some smart traders and top-notch trading platform programmers, with the appropriate financial backing, could pull this off. Come to think of it, it could have been a heist.

The main flaw I see with this though is that someone this smart would also have anticipated the attention that the anomalous trades would attract. In the end, some were actually busted. Could the manoeuvre then have been a decoy/catalyst for something else? Perhaps a huge, leveraged currency position, or one in some other correlated market like oil? If I were an sleuthing man, I would look there. Because of globalization and the interconnectedness of global markets, a foreign power could even set up something like this. Who might want to unload a pile of US Treasury paper, oh for example?

This would make a good movie.

Vince Fulco writes:

Last Thursday was eye-opening on so many fronts…

1) Technology has superceded our humanity– The exchanges and regulators proved themselves completely unprepared and uncoordinated for a growing cascade of one sided activity. What is so infuriating is that there has been a public warning by infrastructure experts and traders about the growing potential for systematic dislocations for a few years and as usual specs have been told, "all is well". Moreover there is evidence of a wholesale and I would say engineered withdrawal of bid side activity. Planes don't just fall out of the sky en masse.

2) Assume at all times that your systems will fail with questionable potential to regain access. I believe IB did the best that it could but I never saw the software behave in this manner after years of observing mkt stress pts. My DOM halted for 1-2 minutes twice with re-newed (displays of) activity 10 pts down each time and then a complete shutdown when SPUs were in the mid 60s-80s. The software came back up after a quick re-login however. Would be interested in behavior of others systems.

3) What we knew on de jure basis; that the exchanges will always do what is best for them, became de facto. Formal decisions as to what to cancel and what level to cancel (60%) were arbitrary, not subject to any outside scrutiny and not challenge-able. I was particularly bemused by the CME's almost immediate claim that their systems worked properly & there would be no trade cancellations even though the activity in cash instruments underlying them still needed to be examined more carefully and in limited circumstances were ultimately canceled. The House wins always in the end.

4) Amazed at the resiliency of human nature– while I am not surprised to see to this week's pop subsequent to ECB/EU/IMF activities, until trading activity fragmentation can be addressed more comprehensively, why are folks so confident that it won't happen again? And soon?

5) Trading is war– Any complacency can have fatal effects. One must always cast a wide net as there were suggestions and pre-cursors in other mkts, as much as 30-60 minutes prior, that would have kept one's exposure down if not non-existent. Always more to keep tabs on, more to learn and more to think about. And that's when fighting the last war.

Rocky Humbert responds:

As students of mathematical logic know, it is impossible to DISPROVE a conspiracy theory — because the absence of evidence is not a proof of anything. Hence I submit that the primary usefulness of speculative post-mortems should be introspection and self-improvement … (i.e. And what does this plunge foretell about the future? And what can be learned from the experience?)

On the first question, I recall a post by the Chair (some years ago), where he noted that when there's a horrible adverse price move in an open position — and the price then recovers, he anecdotally observes that one should exit — as the recovery was a golf "mulligan." We'll shortly find out whether the rally of the past few days is a mulligan.
Also on the first question, I was surprised to observe that yesterday's retail investor sentiment showed only a modest increase in bearish sentiment. Prior to the plunge the bull/bear/neutral ratios were 39/28/32 and yesterday (after the plunge and recovery) the bull/bear ratio was 36/36/26. So retail was evidently not spooked too badly … (I use this statistic as a qualitative contrary indicator.)

For me, the experience of last Thursday reinforces the value of always having dry powder to exploit panic (even if the prices are revisited), as the risk/reward of fading a market that declines 10% in ten days is vastly differently from the risk/reward of fading a market that declines 10% in ten minutes.

I would be most interested in hearing from others what lessons they learned…

Sushil Kedia comments:

If it is hugely profitable to build such a conspiracy, then with all the technology and all the geeks why do such events happen only so rarely?

Has the frequency of such conspiracy explained moves been rising?

The learning that I obtain from such an event, drawing on the Chair's older post of such being the golf mulligan and a recent one wherein he said that such moves clear out the short term longs and the spike back clears out the short term shorts too. So, the markets when turning from day to day battle shift gears for month to month and quarter to quarter battle move sizes, actually then such moves are like a "benign devil". The same way angina pains do trouble but are nature's blessing calling for a more thorough heart check up and recuperative measures to be brought in, moves as these reduce the number of people who would have suffered much deeper damage over a longer course of time in the particular markets.

Can't agree more with anything than Rocky's thought on having some dry power, always.This specific situation of electronic markets (that appear to be so high-tech and hence an illusion of having progressed) disintegrating for moments brings to mind the signature line of Mr. Bollinger: When you progress far enough, you arrive at the beginning!Man must work, to even have a hope to be paid. Any modifications to any degrees in the tools of work will not lead any man (computers too!) to a point where without work and just by stealing anyone can hope to be paid, consistently. Change the system to whatever, men will work even though sometimes thieves will be able to steal. Men may still not get paid upon work and it may not mean that it was someone's steal, since spills happen and will happen.

Victor Niederhoffer comments:

Well said. As Zachar points out and this was originally brought to my attention by someone deeply in my debt, who actually beat me the last time we played tennis, it's a millstein. If the shoe fits, wear it.


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2 Comments so far

  1. douglas roberts dimick on May 15, 2010 12:55 am

    Potpourri: Rules-Based Indications of Markets

    A glance of the headlines of Tradersmagazine.com Weekly Highlights indicates how dependent (and susceptible) participants remain to rules-based constructs and interpretations of market systematics. Consider…

    Industry at Odds Over SEC’s ‘Trade-at’ Idea — High-frequency traders, money managers and major exchanges want the SEC to propose some sort of “trade-at” rule. Broker-dealers that internalize retail orders and operate dark pools say it’s a bad idea.

    Question of the Week — After the May 6 meltdown, are you confident that the regulators and exchanges will install a remedy that will avoid similar problems in the future?

    Europe Tries to Discourage Regulatory Arbitrage — Until an acceptable way is devised to bridge profound cultural differences between Europe and the U.S., “regulatory arbitrage” will remain a profitable enterprise for financial services firms.

    NYSE Traders Take a Seat — Having a seat on the floor of the New York Stock Exchange has taken on new meaning since the Big Board opened its next-generation trading floor in the Main Room last month.

    Tax With Nine Lives Appears Dead — The proposed 0.25 percent securities transaction tax, or STT, is dead in Congress–at least for now.

    Senate Amendment Threatens Off-Board Trading — An amendment to the financial reform bill that many think would restrict off-board trading has already drawn opposition from a securities industry trade association.

    Traders Look for Greater Clarity from SEC-Exchange Sit Down
    See http://www.tradersmagazine.com/eletter/profile/1/578.html?ET=tradersmagazine:e578:54049a:&st=email.

    When considering substantive versus procedural analysis of rules-based constructs (to include electronic exchanges), does the degree of process complexity determine the selection (or mix) of metrics to define a given function (or market situation)?

    For instance, assuming an increasing degree of exchange complexity, independence of indicator correlation may require greater variable assimilation of systematics (or exchange procedures and requirements) to quantify system activity. Off-board trading, generational upgrading of operating systems, transaction tax, regulatory arbitrage, degrees of internalizing retail orders: these elements constitute or impact the central functions of an electronic exchange market.

    Albeit exchange access issues presented since the onset of online retail systems, we may characterize today’s markets as being increasingly “institutional, professional and serious, active trader markets” (see www.tradestation.com/aboutus/comp_profile.shtm). If accurate, what does this priori induction mean relative to understanding and operating within the “regime[s]” of capital flows between concentrations of debt and equity?

    dr

  2. admin on May 15, 2010 8:45 am

    Margin and Credit: Muscle and Brawn or Size and Distance?

    Pondering one’s “Theoretical Query” while perusing Tradestation’s May 4th release of business metrics, I wonder about correlations so alluded as referenced among the “big lender at low rates help the top feeders and flexions in such a regime.”

    TS’s equity client margin balances increased about 4:1 relative to corresponding increasing credit balances. An untrained eye here, perhaps one and the commentators could provide analysis.

    Click here

    See http://www.tradestation.com/aboutus/05042010_bm.shtm .

    Though corresponding assets proportionally increased relative to the credit balances, revenue trades (DARTs) decreased 23%.

    Does such a decrease indicate a distancing between relative activity and relative size of the markets?

    Is it the margin that is effecting (or facilitating) such a flexion of activity or size?

    What are the rules governing the lender-feeder types relative to client disclosed positions?

    Presented by its management as being “recognized as a unique and valuable ‘trading assistant’,” and as a NASDAQ listed firm with “significant advantage in the institutional, professional and serious, active trader markets,” is Tradestation an anomaly or touchstone in such an analysis?

    DISCLOSURE: I have maintained an account with TS since 2003.

    dr

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