Monday, April 07, 2014

A Liquidity Correction

With the onset of High Frequency Traders, not to mention programmed trades by smart machines, the bulk of turnover can be said IS controlled by these "whatchamacallits". I can see a liquidity driven correction happening sometime soon. It kinda happened during the Greek crisis when market makers stayed on the sidelines in light of huge sell orders, thus prompting big price slides to match the sell order. That in turn triggered program based sell orders and cut loss orders, reinforcing the downward spiral. 

When you have so much of the liquidity in the hands of so few people/machines, them staying sidelined in light of a surpernormal order will trigger flash sells which can cause stomach churning down swings even though in all likelihood, these downswing will not lasts more than a day or two once the real cause has been determined. So beware of upcoming flash crashes
John Maudlin's blog:
Before the credit crisis, market makers like Bear Stearns, Goldman Sachs, Merrill Lynch, Morgan Stanley, and Bank of America created a huge amount of the overall liquidity in major markets by consistently taking “the other side” of trades. If the markets were selling, market makers bought, and vice versa.
In the wake of 2008, the big market makers either went out of business, merged, and/or were forced to operate at much lower levels of leverage. The net effect is far less trading volume from market makers and other forms of “real money,” to the point that high-frequency trading and ETFs accounted for about 66% of all trading volume in 2010. While that number has fallen to about 50% today, equity mutual fund flows suggest that higher trading volume from smaller investors, not the resurrection of market makers, is responsible for the shift.
In fact, the following chart from Credit Suisse suggests that the average daily trading volume from “real money” fell by more than half from 2008 to 2012, as high-frequency trading advanced. I do suspect that “real money” volume is rising today with the rotation that is underway into an overvalued, overbought, and overbullish market (but let’s save that for our conclusion).
Understanding how the structure of market participants has changed, let's think about the effect of there being less market-making volume to balance against high-frequency trading and the retail/institutional herd.
On May 6, 2010, the markets sold off for most of the day, and market makers expanded their volume as the media ran all-day coverage of a small riot in Greece. But (and this is critical), market makers who can no longer buy at 40x leverage will carry only so much inventory overnight. At some point market makers must stop buying ... and they did when a large sell order came into the market toward the end of the day on May 6. The market makers stepped back instead of providing liquidity, precipitating a sharp drop in prices. Then many of the HFTs shut their systems down, seeing an irregular trading pattern and fearing another “Quant Crisis” like the one in October 2007. Liquidity dried up in a matter of minutes, and the market went into free fall triggering stop losses and emotional selling from the general public. (As they saw the market collapse and the rioting in Greece, people may have thought, “Something big just happened and I am late... sell everything!”). Without market makers to provide volume, an orderly sell-off became a chaotic collapse.
Now, with market-maker volume way down, a similar situation could develop again; and once again the general public will rush to sell if liquidity evaporates. We should really think about this dynamic, because the next correction may look more like the stock market crashes of 1929 or 1987 as opposed to the more gradual "cascading crash" we all experienced in 2008.
With that in mind, investors will do well to pay attention to the ever-changing structural makeup of the markets before blindly jumping in. Just because US stock markets – along with a lot of the major markets around the world – have found new highs since 2008 doesn’t mean they have healed structurally. It doesn’t mean they are stable. And with long-term valuations at historic levels, both on an absolute basis and relative to the rest of the world, US equity markets are both unstable AND overpriced.
The inevitable correction that is coming to US markets could be a catalyst for a downturn in the broader economy, and without much of a warning. It could be another lion, prowling through fiber-optic cables, data feeds, and stock exchange servers.
I continue to believe that high-frequency trading should be reined in. It is creating the illusion of liquidity, which can dry up in a heartbeat while at the same time sucking billions of dollars from the trading of individuals and institutions.


bruno said...

With such beauties here gives me more confidence that my forcast of 12k,give or take 1k for the Dow at year's end will become a reality.End of next year 8k-6k or lower?This coming bear will be a mean one,really really mean.You better believe it.

panaceaasia said...

Thank goodness you are featuring (beautiful) sexy women again. Your taste in women is excellent!

panaceaasia said...

Thank goodness you are featuring (beautiful) sexy women again. Your taste in women is excellent!

bruno said...

Looking at beautiful babes(even pics) make my mind or brains works wonders.

Anybody remember when the JPY went skyhigh and the Nikkei hit rock bottom(from 40k-6k).The financial wizards blamed it on deflation.

Now,at present the European markets are doing worse than the US markets.

Yields in the US are swimming further away from their European counterparts.

The US economy is doing better than the EZ.

The financial mess in the US is better than the pothole financial mess in the EZ.

Yet the Euro is holding very well and is very resilient against the greenback.

The Dow is down around 130 pts now and the Euro is up 40 pics against the greenback.

There are two reasons that I cannot figure out,which is which.

First,is it the ugly D Word called DEFLATION.

Or is it because of delevaraging and therefore repatriation of capital invested overseas.

If it is deflation then history tells us that the European markets will sink through the bottom of the ocean.And the Euro will soar till the sky's the limit.

If it is deleveraging and repartriation of capital it will just be a matter of time before the Euro falls apart and maybe to under a buck.

For now we will have to give it the benefit of doubt that it is deleveraging and repartriation of foreign funds.The next few weeks will tell us or rather give us the answer.Whatever it is,you boys and gals out there do not need me to tell you what to do.If you do then you better close your trading account and go fly kites.

One more thing.Be very careful about the stock markets.Now is not the time to buy.Rather it is now time to sell,keep your cash under the pillows or matresses and make sure no unauthorised person or persons enter your bedrooms or homes.A year or more from now,and you will be thanking yourself for listening to unpaid well meant trading advice.Then you can take your well kept money and go out and buy blue chips a few ringgit for a bunch or bunches.Be patient,stay disclipline and you will be a happy camper(trader)a few years from today.Cheers.

Kevin Wong said...

Ordinary investors like me fears market turn bearish. Savvy investors see opportunities in bear market instead. while traders, fret everyday no matter marts goes up, down or even flat!

Stock markets are engineered to go up over the long term, if not - then its the end of the road for investors!

bruno said...

There are savvy investors and the not so savvy investors.And also the very long term investors who bought stocks,keep them buried in containers at the backyard or lock them up in drawers or safe deposit boxes,throw away the keys and come back twenty years later,hoping everything is fine.

From my years of experience,what seperates the winners and losers is not being a rocket scientist or a layman.In the end what seperates the winners and losers are street smarts and ego.

Kevin Wong said...

All we market players are in this game of making money. For me, value/trend investing is is the way. Its the least stressful & not time/energy sapping when compares to trading and/or trying to time or outsmart marts in a daily,weekly or monthly basis. When i'm wrong , i would quickly correct it - as pride & emotion are the biggest enemy of this money unforgiving game!
Of course, what works for me - may not for you. If, trading is your cup of tea - so be it!

I do appreciate all those who are willing to share their market tips, adventures, comments, forecasts, success, failures, mistakes, warnings..... As, i writes also is to help others too. Yes, i believe that what we reaps-is what we sows. I also believe in the law of attraction - do good & be positive, and good & positive will..... !

Good luck, success & good karma to all my fellow investors, traders & speculators out there!


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