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Monday, May 10, 2010

ALL ELSE BEING EQUAL


I know generally when this phrase is used to talk about something it usually means that all else is not equal. Here is a prime example of that. The QID which is an inverse ETF should essentially sky rocket on a day like we had last Thursday, yet we see a death spike down intraday. How can this be? Isn't this a vehicle designed to protect against downside movement? If we had the foresight to have seen this coming shouldn't we have been able to profit from it?

First of all, I would agree that in this instance the trades executed on the dip should have been busted by the exchange. For this to trade way down should be impossible and nobody should have been able to buy this that low during a monster down day. The price should have traded straight up all day long. Electronic death spikes are a problem in the markets and we are seeing more and more of them. In the old days where people executed the transactions, these types of things did not happen. I see no way of this type of trading being completely unwound. ETF's are in general liquid if you look at the total volume in a day many of them trade, but they do not trade intraday in a very liquid fashion. This is especially true during a volatile period like last week.

One thing we do want to keep in mind, and it is now more true now than it has ever been. The powers that be do not want people to be able to make money of declines in general. Remember that blockhead from Michigan grilling the Goldman Sachs guy. For the most part they want to rig everything to always increase in price. Unfortunately, it it this very "fixing" of the game that causes huge imbalances which create these big vacuum moves where values revert to the mean. Artificially lifting the market almost every day with last hour buy programs like the PPT has been doing pushes values way beyond where they should be. The rubber band can only stretch so far before it reacts.

Yes they have given us these vehicles to trade that should allow us to profit if we use them properly, but they are inferior to futures. I know alot of people want to avoid futures because they think they are more risky. This is just false. Risk comes from liquidity, and there are not many things more liquid than index futures. ETF's are not even in the same conversation as far as that goes. How can something that is more liquid be more dangerous?

If you insist on playing the vehicle that is less liquid, you have to take the good with the bad. There are limitations and you have to deal with them. In this above case, in the end the right thing was done which is a rare case nowadays with our government. This ETF ultimately rose and the erroneous trades that should never have occurred were invalidated by the exchanges. This is a good thing not a bad thing. The best thing you can do is adjust your size accordingly when playing these ETF's. They have limited trading hours, and often things happen outside of when they are open, so you will have both bigger wins and bigger losses. If you look through the stats over the last several years, you will find that the majority of the net moves in the indexes have occurred during non-us trading hours. As a result, relying on vehicles that trade primarily during the hours other than those where the moves are happening, is very risky to me.

I take half the size in these trades as a result of that due to knowing they are in reality not very liquid vehicles. For those who wish to avoid futures, that is the best thing for you to do. Also, mentally accept the limitations that are here. If you don't like them, open a futures account.

Just like Ackroyd said in Trading Places just before they went into the pits to whack the Duke Brothers, "Fear, that is the other guys problem."

2 comments:

Anonymous said...

thanks for your thoughts on this Chris. It was very helpful.

I find it interesting what happened. The issues it raises are immense. Let's say what happened with these stocks is true (they fell because the orders were routed to other less liquid electronic exchanges). Well I wonder what my broker does? Do they do this as well and i have only been lucky thusfar? Also if they agree on the universal circuit breakers, the timing can be tricky. First the exchanges need to write the code to implement the triggers, then they have to agree who initiates the trigger, then they really need to synch up. I mean if you have high frequency firms acting on the ms timeframe you can't just email the circuit breaker notice. Maybe they need atomic clocks ...

I also wonder if part of the trading that caused the problem was the etf sponsers (or whatever they are called) trying to track their appropriate indices.

It might just be that the structure of the market is now broken due to all the high frequency trading. It just seems that since no one wants to reveal their intent, the bids sitting in the books are always thin, that sets up this scenario where a fast change in the market just blows through all the bids down to that last penny. It seems to be glossed over but the underlying issue may not be easy to fix and it might not be a black swan fat tail type of event.
Mike

Chris Johnston said...

Clearly there are some issues as to the mechanics of all of these things. Ironically, the government has rigged everything to go up, so when things start to go down this is what happens, all bets are off. More evidence of all the added tinkering hurting rather than helping. There is a shocker.

I you just risk 2% per trade which is what I do, then even in a haywire event where everything goes wrong you are not likely to get hit for more than 10% as long as your trades are not correlated.

I rely on this for my living so I am not worried about this at all to be honest, although I do most of my trading in futures. I still have made close to 60k trading stocks this year so I do still have some interest there albeit a complimentary one.

I accept the risk when I put the trades on and generally risk about 1% per trade in stock trades only due to the larger risk with them and the greater chance of an outlier event.

I get a kick out of Bill O'Reilly crying foul that it has to be a fix when things went down. What about how they have been going up?

Then he brings on the "expert" Stuart Varney who appears to have no knowledge of how trading works at all. What exactly makes him an expert? I wonder if he has ever made a trade? Those two should be on stage at the comedy and magic club.