Be afraid.. very afraid… program trading by hedge funds now accounts for upwards of 50% of total volume. And they’re trying to get smarter, cleverer, and more devious every year. In any other arena, the methods they use would be illegal, but not in the stock market. You must read this article from thestreet.com. It will confirm your worst fears. I’ve highlighted a couple of sections particularly familiar to AAPL holders. I’m making this a sticky for a day or two, because I think its important everyone reads this and realises that there really are gremlins in the machine.. they’re called hedge funds, and they’re our worst enemy, except when they’re on our side

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How to Handle the Rise of the Machines

By Alan Farley
RealMoney.com Contributor
5/3/2007 12:42 PM EDT

The Feb. 27 selloff might augur a historic, program-trading-driven meltdown.
Regulation NMS will expand the number of electronically driven trades.
Small market players need to ignore market depth and exit when price action seems unnatural.

Multinational big-cap stocks are outperforming small-caps by a wide margin. This is a major problem for technicians, because we’re taught that rallies narrowly based on the most-liquid issues are destined for failure. In fact, these types of uptrends often represent the last gasp in long-term bull markets.

But I’m not ready to predict a secular downturn, because smaller stocks still have time to get their acts together and join the blue-chips at new highs. But it’s something to watch as this curious spring market continues to unfold. In the meantime, it’s a good time to raise cash and keep a generally defensive posture, despite the bullish headline numbers.

Traders know what a tough market this really is, as waves of stealth selling pressure hammer the majority of our positions. This computer-driven activity is triggering some of the whippiest and most uncomfortable price action I’ve seen in years. Liquidity is also a myth these days, with bids well under the market vanishing on each downdraft.

Rev Shark has done an excellent job in recent weeks pointing out the frailty in this twitchy tape. Indeed, you aren’t making money this spring unless your efforts have been focused in a narrow range of opportunities. More likely you’ve gotten cut to shreds as technically sound stocks have ripped through logical stop-losses for no obvious reasons.

We’re also seeing a ton of “ganging” behavior, where hedge funds bully down prices on strong stocks at the open, hoping to shake out as many longs as possible. This type of manipulative activity isn’t possible without a high degree of coordination between these folks. But that’s illegal, isn’t it? Oh never mind, I’m just being paranoid.

In the meantime, we’re seeing insane rallies, such as Amazon’s (AMZN - commentary - Cramer’s Take) 19-point slingshot last week. In normal markets, the public would drive this type of parabolic activity, not realizing that profits were dependent on quick and timely exits. However, the public doesn’t seem to be participating at all in this latest wave of rocket launches.

Rather, I suspect that institutions are pushing up these stocks, trying to play catch-up after the February nosedive. Performance is everything on Wall Street, and many of these folks are trying to get ahead of the curve as the summer months approach. Unfortunately, it looks as though the dynamic of supply and demand is taking a back seat in this odd parabolic sideshow.
The public got scared out of the market in the first quarter and isn’t likely to return until later this year, at the earliest. That’s why sentiment numbers are lower than expected despite the Dow Jones Industrial Average’s run to new highs. It’s especially telling that Joe Sixpack doesn’t care that the Dow is trading over 13,000. He’s too busy trying to recover from the February selloff and would rather drink beer or play golf than fool around with the stock market this spring.

Have you sat back and really thought out the Feb. 27 selloff? That session revealed a major structural weakness in the world financial markets. Algorithmic trading programs triggered that ugly event, instead of panicky human sellers. In fact, it might never have happened in a legitimate supply-and-demand marketplace.

The session might be a precursor to a historic meltdown in the not-too-distant future. On that day, we found out that billions of program-driven shares can inflict serious damage when they’re lined up on one side of the market. These cold lines of code are emotionless, so they remove classic greed-fear buying and selling behavior from price development.

Then consider the impact of upcoming Regulation NMS, which will require trades to be executed at the best price available at the time, regardless of exchange. Institutions are now spending nearly $1 billion per year to upgrade their systems to speed up executions, bring the majority of business in-house and accommodate new rules.

Add in penny options and experts predict that electronically driven volume will expand from 4 billion to more than 130 billion daily transactions by 2010. Unfortunately, the institutions building these futuristic systems don’t have a real understanding of the potential consequences. So we’re all at risk.
Think-tank Tabb Group pointed out in a 2006 report that “as the algorithms become more complex, there is a danger that the interfaces will become cluttered and indecipherable.” In other words, they’re admitting the possibility of a doomsday scenario in which the worldwide trading systems go out of control.

Unfortunately, the Securities and Exchange Commission is way behind the curve with these electronically driven markets. That means they’ll be implemented in an essentially unregulated environment. It reminds me of a Cold War-era science fiction movie called Colossus: The Forbin Project, in which two electronic missile systems hook up and take over the world.

How can relatively small market players deal with this nightmarish surge of automated trading? First, we need to throw away our market depth screens, because the vast majority of volume is being hidden from public view. Second, we need to jump back to the sidelines whenever price action defies the natural laws of supply and demand.

Pretty price charts can’t help us when program trading moves the tape in unnatural directions. And it’s a mistake to try to outthink these complex strategies. There’s a reason that institutions are recruiting top programmers from the nation’s best colleges. They’re hiring people to build algorithms that outthink human traders, like you and me.

Re: Hedge Funds’ Machines Run The Markets

[quote author=“Tommo_UK”]Be afraid.. very afraid…

Are they not still subject to trading curbs? 

Just curious, but I am very concerned about the lack of regulation regarding Hedge Funds. Seems like it’s going to require an “event” before anyone at the SEC really takes notice.

HAB

Re: Hedge Funds’ Machines Run The Markets

[quote author=“HotAirBaffoon”][quote author=“Tommo_UK”]Be afraid.. very afraid…

Are they not still subject to trading curbs? 
Just curious, but I am very concerned about the lack of regulation regarding Hedge Funds. Seems like it’s going to require an “event” before anyone at the SEC really takes notice.
HAB

The problem with hedge funds is that they can use stock and derivatives, so they can do whatever the hell they want without being seen. They can use CFDs to be completely invisible, and play around with options to game the common stock. Its impossible to regulate these people because they’re so slippery, and so mercurial in their ability to slide from opportunity to opportunity with a few key presses, that they defy the very imposition of controls. They’re like gangs of thugs on bikes which can’t be seen by radar detectors, are invisible to helicopters, and faster than any police car on the planet. You don’t know they’ve been anywhere until they leave carnage behind them, and you don’t know where they’re heading to next.

The only way I can see to control them would be to force fuller disclosure of their positions, and in particular daily reporting of short interest rather than the absurd monthly reporting we get now. That, and proper accounting for the options chain.

If more information was available, then the ability for these crooks to game and control the action would be much diminished because their shenanigans would be more transparent and open to scrutiny. Controls won’t work, but having to show their hand to a great degree would lessen their power considerably. They’d have to resort to GASP buying good stocks of well-performing companies, and DOUBLE GASP shorting/selling bad stocks of under-performing companies. They’d even have to do some real fundamental research, rather than just relying on algorithmic trading, so they could pick real winners.

So as I’ve said, I feel trying to control them would be a dead-end. But opening up their trading to greater scrutiny and reforming the reporting of short selling (and possible tightening up the rules around shorting) would do wonders to level the playing field - a playing field now so rigged by these shysters that its hard for anyone else to stand a chance.

Re: Hedge Funds’ Machines Run The Markets

[quote author=“Tommo_UK”]They can use CFDs to be completely invisible…

I’m don’t think I’m familiar with CFD’s - can you recommend a site (link) to bring me up to speed?

TIA,

HAB

Re: Hedge Funds’ Machines Run The Markets

[quote author=“HotAirBaffoon”][quote author=“Tommo_UK”]They can use CFDs to be completely invisible…

I’m don’t think I’m familiar with CFD’s - can you recommend a site (link) to bring me up to speed?

TIA,

HAB

http://en.wikipedia.org/wiki/Contract_for_difference

there you go
basically it’s extreme margin trading
btw, can an American hedge fund trade CFDs in Europe (as they are not allowed in the US) without having to report it in Europe or the US?

Re: Hedge Funds’ Machines Run The Markets

[quote author=“MaCroissant”]btw, can an American hedge fund trade CFDs in Europe (as they are not allowed in the US) without having to report it in Europe or the US?

Most hedge funds aren’t based in the US… they hide out in London or exotic locations like the Bahamas, or Grenada, to avoid too many people poking around their affairs. Anyway, they can set up subsidiaries anywhere they want to trade CFDs. National boundaries don’t mean anything any more.

Re: Hedge Funds’ Machines Run The Markets

[quote author=“Tommo_UK”][quote author=“MaCroissant”]btw, can an American hedge fund trade CFDs in Europe (as they are not allowed in the US) without having to report it in Europe or the US?

Most hedge funds aren’t based in the US… they hide out in London or exotic locations like the Bahamas, or Grenada, to avoid too many people poking around their affairs. Anyway, they can set up subsidiaries anywhere they want to trade CFDs. National boundaries don’t mean anything any more.

Well, you’ve got my attention - very concerning. As if options/futures weren’t enough. This is akin to hyper-gambling, and it’s just asking for a disaster.

Another site compliments of Google:
http://www.ukcitymedia.co.uk/whatarecfds.html

I guess my question at this point is whether the SEC could even prevent U.S. companies from being CFD’d (to use it as a verb)? Seems out of their control.

HAB

Re: Hedge Funds’ Machines Run The Markets

[quote author=“HotAirBaffoon”]I guess my question at this point is whether the SEC could even prevent U.S. companies from being CFD’d (to use it as a verb)? Seems out of their control.
HAB

Its out of their control. CFDs aren’t shares, they’re just instruments traded which are based on the underling share price, hence the “contract for difference’ moniker. No national regulator like the SEC can touch them.

I trade AAPL CFDs from London. In fact, the US is one of the very few countries that doesn’t permit CFD trading, hence the popularity there of options.

guess I’ll have to review my theory that European-markets are going to suffer from a crash because of exagerated margins on certain types of instruments… (similar to 1929 in the US)
If something happens, it will be on a global, the question is when & what will be the catalyst… (as usual)

[quote author=“MaCroissant”]guess I’ll have to review my theory that European-markets are going to suffer from a crash because of exagerated margins on certain types of instruments… (similar to 1929 in the US)
If something happens, it will be on a global, the question is when & what will be the catalyst… (as usual)

Read about it HERE

:o :o :o :o

[quote author=“MaCroissant”]guess I’ll have to review my theory that European-markets are going to suffer from a crash because of exagerated margins on certain types of instruments… (similar to 1929 in the US)
If something happens, it will be on a global, the question is when & what will be the catalyst… (as usual)

This topic brings up an interesting economic/philosophical question I’ve always wondered about. Is there such a thing as too much or too little ability to margin? For example, after the 1929 crash, margin abilities were reduced. CFDs are still available today. Does increased margin ability imply a good or bad future for the markets, and why? It seems the politicians have determined our margin abilities based on fear, emotions, altruism, similar to how our central bank bails out reckless companys with public money on the grounds of the greater good. But what do economists think of margin?

in my opinion margin or any form of leverage is very important. Difficult to make a fortune without it. But more important is one’s personal money management. how individuals use margin or leverage could be the difference between success and failure whether its stocks, commodities(where only 1% is needed on some contracts) or counting blackjack cards in a casino the key is money management. The best experience one can have at an early age is too much margin, lose all the stock as it goes down and have no cash when it turns around and goes back up (Whipsawed)

The crash of 29 the allowable margin was 90 percent (10 percent down) but it is the domino effect without a FED to bail out the banks that began that sorry era of history. lets hope that when the hedge funds start to topple it does not have the same result.

Superbaka, you raise several very interesting questions, and though we might find some essays/books online on the matter, I think that the subject is as obscure to academics as it is to investors (same for options&co;)

[quote author=“superbaka”]
Is there such a thing as too much or too little ability to margin?

Margin wise, I think it’s important to make a difference between instruments capable of inducing margin calls (i.e. stock for margin) and instruments which are leveraged, but “stand on their own” (like options)
Too much margin on the latter can’t hurt a fly (well, it may wipe out a trading account ), but I think that a 50% limit on stock seems reasonable to me. Even if the Fed may be able to cover a massive lack of liquidity, a 10% margin is just too much to handle.

It would take a precise study to see how many traders trade on margin, with how much “spare cash”, what the average holding time would be and how much money it would take the Fed to put some balance into a freaky market (blackmonday like )

[quote author=“superbaka”]
For example, after the 1929 crash, margin abilities were reduced. CFDs are still available today. Does increased margin ability imply a good or bad future for the markets, and why?

Margin ability will only be reduced if *somethingverybad* happens. I think that today, any Fed/national Bank feels ready to take on such a crisis, not because they’re obnoxious, but because they can work together on a global scale and limit damage to an isolated case.

But in order for such a catastrophe to stay isolated, investors would have to act rationally and take a liquidity-crash for what it is: a financial disbalance which isn’t related to an economy’s health.

Unfortunately, a crash implies panic, and global markets will collapse under the weight of positions getting aggressively sold by fear-struck investors fearing that the Fed won’t be able to support the crash. I think it’s important to mention that such a collapse would take everyone by surprise and only a few rare investors/funds will be prepared.

[quote author=“superbaka”]
It seems the politicians have determined our margin abilities based on fear, emotions, altruism, similar to how our central bank bails out reckless companys with public money on the grounds of the greater good. But what do economists think of margin?

Margin trading is unavoidable: if traders wouldn’t be able to borrow money from their broker, they would get the money somewhere else, and in which case a crash would be much harder to offset by the Fed. With brokers allowing margin trading, the Fed at least knows who’ll need the extra cash

Economically speaking, I think that margin can be compared to buying a house with a margin downpayment (10%, 30%, 50%, or no downpayment at all). Mortgages are a necessity to keep the economy going, whereas margin for investing&trading;, is a money-making business for banks/brokers (interest rates are around 10-11% on E-trade for instance!). This may lead to catastrophy but it is tolerated by government as long as it stays within certain boundaries (judged to be 50% in the US).
Which brings us to your first question “is there too much/too little margin?”
This needs extensive study, but today I think that we can already say that the truly worrying part is CFDs & co

The kingpins of the hedge funds are certainly raking in the $$$:

http://www.nypost.com/seven/05052007/gossip/pagesix/pagesix.htm

“The top 20 hedge-fund kings earned an average of $658 million last year, compared to a $145 million average for the 20 highest earning CEOs.”

Unfortunately this is at the expense of the retail investor ...

On another note ... the article mentions that Michael Dell pocketed $153 million ... I guess cost cutting doesn’t apply to him.

This topic is hard for me to understand.

I think it means the average investor is likely to be hit on the short term (i.e.daily) swings.

I take it that the long term price of a stock is independent of this kind of activity.  True?

[quote author=“hledgard”]This topic is hard for me to understand.

I think it means the average investor is likely to be hit on the short term (i.e.daily) swings.

I take it that the long term price of a stock is independent of this kind of activity.  True?

I suggest investors ignore the day to day swings and focus on the long term. Over a period of months and years share prices tend to float toward rational fundamental pricing. Although sahres prices don’t trade at rational prices constantly, my goal is to find the tmes the share price is significantly oversald to buy and watch for times in the cycle when the stock is significantly over bought to take gains and wait. I’m a believer in the long-term value of AAPL. My trading is an effort to maintain a strong position with modest “tweaking” based on the market cycle to improve long-term gains.

Right now I think most are clueless about the potential for the iPhone and IMHO it’s a good time to buy.