Mereja

Author: Sell Puts

  • What Do Baseballs, Gravity & Program Trading Have In Common?

    (This post originally appeared on the author’s blog)

    This post is intended to provide you with a deeper understanding of where I think our markets are going, how we got here, and why. I concluded my previous post with the question: “How should we model our current and future markets? Should we base them on previously proven market making strategies or should we venture into the unknown/unproven (algo/program) territory?

    First, lets compare our current and past markets bullishness.One argue in years past bullishness was supported by a fundamentally strong market/economy correct?… Well then our current similarly bullish trending market MUST be supported by fundamentals! No problems here! If you are saying to yourself, “This guy is nuts, our current market is nothing like the past!”, you are in the right mindset to continue reading.. Though much to your dismay I am not nuts!

    My brief thesis is as follows:
    I believe the current speed of communication combined with the proliferation of electronically correlated markets have created a unrealized/unproven medium for gov/banks to simulate a healthy market via trading trickery regardless of where true market fundamentals lie.

    In past buying the buying of fundamentally strong markets was rationalized, warranted and encouraged because the economy *appeared intact and growing. During these markets, dips were bought, fresh retail money gushed, thus was no need for “intervention” as we trended for 15 years until 1999-2000. Then 9 years of wild gyrations commenced, which turned out to be the markets way of informing the street the house was burning(still burning IMO). The (still) burning house which took 9 years of smoldering to ignite now has “crashed” “bottomed” and “almost recovered” in one year. CNBC would say; “Crazy, This is a record recovery!” Well, not really considering we are in an age which information is delivered instantly and a few key players control the entire market ebb/flow via ETF’s and free money(TARP/SLPs).

    The few key players I mentioned above(we are all very aware of them) “thought up” a way to ramp our markets via trading trickery. “Thought up” meaning: Once the major banks realized there was a natural liquidity vacuum that was not going to plug itself, they devised a way to put our markets on life support.

    *The easiest way to jump start a heart is a shot of adrenalin, the markets needed a shot of adrenalin after 2008. The markets syringe was filled with cash, injected directly via preferred share purchases and the creation of Supplementary Liquidity Providers. It was widely known major banks “pre 2008 crash” had been working with algorithms and HFT trading, though “pre cash injection” banks did not have the adequate ammo, regulatory head nod and or a real reason to release the unproven programs in full scale. Post crash & cash injection it was a different story. Once the banks concluded the best way to revive our markets was to put the new found piles of cash to work in the market via HFT and algorithmic program trading.This was only possible after the banks received a regulatory under the breath “go ahead”. The programs were released in full scale around Dec 2008 and have not been scaled back since. Now that all the firms know the “trading trick” they have by chance or design engineered a very focused and highly coordinated “recovery” which completely ignores the absolutely garbage/depressing fundamentals. The programs have created a market which naturally falls at any given moment until the programs step in “throwing” the market back into the air.

    None of this would have been possible if not for the recent IT advances in trading technology. Now that the technology is readily available, our markets are now 100% running on what was intended to be temporary “life support”. At some point the programs will run out of money and the markets will then search for natural bids, *If any exist. The following analogy might help you better visualize how these programs are indeed keeping the markets from seizing up.

    Think back to when you were a kid tossing a baseball onto the roof of your house/garage. Remember how hard it was to, first predict where the ball would roll off and second to catch the ball ounce it erratically popped off the gutter? Think about doing this for a year without dropping the ball once. It is not possible right? Now replace the baseball with “the index(s)” and your glove/arm with “life support programs”, when the programs ramp us hard the index(s) are being thrown back onto the roof. As the index(s) trickle back with gravity they approach the edge of the gutter, (or support) the index(s) reacts unpredictably before plunging towards the “life support programs”(glove). Since they are so fast, their gloves are always in place to catch the ball. The program then throws the ball back up onto the roof.. and repeat, repeat. Sometimes the ball(index) gets a bit closer to the ground causing the programs to scramble around the driveway wildly, though the ball is always eventually scaught.

    Until we can throw the ball over the roof effectively putting an end to the cycle we are playing with fire betting against gravity. Eventually what goes up and is not securely held in place with permanence (FUNDAMENTALS) must come down. So are we on our way to 20 more years of up trending? Probably not. The markets need a real catalyst that will naturally keep the ball from rolling back off the roof, the life support programs created by banks are simply playing pitch and catch with only one participant, it can only last so long before the fun is over.

    In closing I will leave you with an alternative theory explaining why our current markets are they way they are: Basic economics 101 tells us it is possible with enough capital and knowledge of the market to cause distortion in perceived real “demand” thereby cornering a market *artificially driving the price higher. Or for those who did not sit through Dr. Self’s Econ 101; “to purchase enough of a particular stock, commodity, or other asset to allow the price to be manipulated“, much like crude traders the past year(s). Could this be what is happening to our markets on a huge scale? Perhaps the “true demand” or market price(s) remains drastically lower? If this is the true what will happen when the manipulator is outed, or exits the market? Am i saying this is happening, not exactly, though I do believe massive collusion is possible if enough parties are “in the know”.

    The most boring yet most widely believed explanation i have for you is: The buying could just be systematic “price discovery” programs pushing the index(s) up to resistance levels to reveal if fresh buying will follow. Either way, if we keep going up why not ride it….Only time will tell.

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  • A Simple Guide To How Algorithms Are Manipulating The Market Right Now

    (This guest post originally appeared at the author’s blog)

    I am growing more and more tired of seeing what appears to be a very “helpful” algorithm running in the SPY. I am using the term “helpful” very lightly. I relate this algorithm to a jumper cable, your car will run once you get the jump if your battery is running low right?

    Now lets say volume in our market is equivalent to a discharged but not quiet a dead battery yet. Symptoms of the market being a “dead battery” are sluggish movement through key pivot levels on a daily 1 min chart, along with violent price spikes within the 1 min candle.

    So how do we fix a market which does not have the Umph it needs to stay liquid and trade while not remaining flat all day after the initial 30 min opening volatility? A quant algo of course!

    First a little background on why the SPY would be a good target for some undercover manipulation. As you may or may not know ETF’s run our retail markets. The S&P depository Trust buys and sells individual components of the S&P’s based on movement within the index. Simple right? Well if you say, “Screw it, I am purchasing the 500 S&P components via the SPY ETF. Now i can buy little pieces of the components without laying out the cash to buy them individually.” GREAT! If you are a buy and hold investor looking to leverage your hard earned dollar. Now lets think about how the normal operation of the SPY can cause manipulation…

    *If there is a huge buyer day in and day out of the SPY whom has no interest in holding for a long period of time how would this affect the components? The direct affect of SPY purchasing would cause the cash market(individual stocks, not futures) to trade in a much more liquid manner in whatever direction the purchaser is leaning.

    Now for the juicy stuff,…For months now i have been watching a specific algorithm push our markets around with great ease. It looks like this algo is giving the SPY a little push through support and resistance levels with massive size executed in seconds. Sometimes the push is tens of thousands of shares, the size all depends on the natural volume around the level which the SPY is trading at the time it may need a “Jump”. For instance if the market is oversold on a 1 min time frame and is trying to break higher off lows but just cant get the party going on its own, the algo will come in and take offers until day traders, scalpers, swing traders jump in and chase the market higher. Once the price gets “jumped” the algo just sits and waits till natural buyers and sellers are few and far between and it either dumps or takes in more. Usually the program will reset itself after a trade, then will wait till it senses low volume once again.

    For some concrete evidence of this action I have done a quick illustration, which includes Time & Sales which only display prints on the exchange the algorithm does business on. This exchange is used because of its very nice rebate structure, and it allows the algo to exploit the SOES, meaning it cannot trade in blocks larger than 10000 shares per order. So what does it do, it takes blocks almost 10,000 shares multiple times a second, this price action causes the market to lift violently. This is not small money, remember small money follows big money.

    The algo in question starts buying at 110.04 with one block of 9999 shares, followed by 60k more shares all bought in under two minutes. You can see from the chart how the SPY reacted, it violently moved higher all the way up to 110.55, where the algo dumped just about all of the shares, you can see the prints in the “dump” prints window, again only showing the print from the exchange the algo does business on. The algo did its job, the cash market snapped back, the components again caught a bid and moved higher through resistance. I.E. they look alive and well… Natural buyers came in above the 110.55 level chasing the market up another 50 cents or so before they left and the SPY fell again because the volume was not there to support the massive run up which took place over 15 minutes. As you can see the algo works in two capacities, it manipulates the market to the upside along with keeping S&P500 components trading in a liquid orderly “non flat” fashion.

    The 650,000,000,000$ question now is.. What would our markets look like if this “jump starting” was not taking place every day? I think you know the answer.

    Click the image below to see how it really works.

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