Monday, May 10, 2010

Inflate away your debts

The US policy of kicking the can down the road has proved to be surprisingly popular around the world. The EU went from "things are fine" on Thursday to "the world is coming to an end" by Sunday night. Again, rather than dealing with the issues in front of the EU they have chosen to deal with the issue of too much debt by taking on more debt.

I think the markets reaction to this after the initial short squeeze may be interesting.

** Update: Today's headlines will all read how the market soared the most in more than a year, but there are a couple of interesting notes. The market soared on the open and it took a massive push from the autobots at the end of the day to finish near the highs. More importantly the Europeans put up nearly a trillion dollars to defend the Euro. The initial reaction was positive as the Euro jumped to $1.30 US, but fell back to roughly unchanged by the end of the day at $1.27. You can't throw a trillion dollars at the market every day (well, maybe you can but it's generally ill-advised).

This is perhaps the best summary of the May 6th market meltdown that I've read:

" Today’s price swings in a great number of stocks highlight the inherent and systemic risk of our automated stock market, which has few checks and balances in place. Once the market sensed stress, the bids were cancelled and market sell orders chased prices down to the lowest possible point.

We read this in a recent comment letter to the SEC about HFT and couldn’t agree more: “When markets are in equilibrium these new participants increase available liquidity and tighten spreads. When markets face liquidity demands these new participants increase spreads and price volatility and savage investor confidence.”

Today’s severe market drop should never have happened. The US equity market had at been hailed as the best, most liquid market in the world. 
The market action of May 6th has demonstrated that our equity market has major systemic risks built into it. There was a time today when folks didn’t know the true price and value of a stock. The price discovery process ceased to exist. High frequency firms have always insisted that their mini-scalping activities stabilized markets and provided liquidity, and on May 6th they just shut down."

One of the other questions I've been asked is: "Someone made a killing right?" Well, there was actually very little stock traded during those volatile minutes but considering the cancelled trades its highly unlikely that anyone made a killing and it is very likely that some people ended up in a very bad situation.

Consider a stock that fell from $45 to $1 before closing at $39. Let's say you were the lucky duck that bought a 1,000 shares at $1. As the stock began to rise you quickly sold it at $25. Congrats, you just made $24k pre-tax, right? Wrong. The exchange has decided to cancel your $1 buy because obviously the market was out of line, but they let the sale at $25 stand. So, now you are SHORT 1,000 shares at $25 and the stock is trading $40 - basically you have a $15,000 paper loss. Doesn't that make you feel confident that the system is working?

Finally, can we please stop calling Goldman Sachs a bank? They are a hedge fund and a really, really, really good hedge fund, but this notion that they are anything but a giant day-trader is silly.

Consider that they didn't have a losing day in the first quarter. NOT ONE DOWN DAY!

"Daily trading net revenue was $25 million or higher in all of the first quarter’s 63 trading days, New York-based Goldman Sachs reported in a filing with the U.S. Securities and Exchange Commission today. The firm reaped more than $100 million on 35 of the days, or more than half the time."

More than half the time the firm is generating over $100 million a day! My greatest awakening occurred late one night at my office in the World Financial Center when I mentioned to a colleague that it seem so silly that we were paid so well when we created nothing. That's become the entire business model at GS.

It's a heads Goldman wins, tails you lose world - get used to it.


Anonymous said...

It is possible that Billions were lost in the big drop due to the prevalance of stop losses in place to protect gains. In fact don't some e-accounts have a way that an individual investor can automatically walk a stop loss up with the increased value of their holdings? I think all trades outside of 1% during that time frame should be cancelled, because otherwise it bordered on fraud if it wiped out peoples positions with auto stop losses.

The Artful Blogger said...

It's a good point re: stop/losses.

It's important to differentiate between limit stop losses and market stop losses.

A limit stop loss says if the stock hits $20, sell the stock at no less than $19.95 or something like that.

The more common stop loss is the market stop loss. When the stock hits $20 your order to sell goes in to the market to sell "at the market". Normally, this is fine and you'll sell the stock at something near $20. Unfortunately, in the midst of the freefall last week, the market bid were pulled and thus in many stocks the market bid became the autobots at $0.01. Scary stuff indeed.

Thanks for the comment!

Anonymous said...

I was thinking of the "Trailing Stop Loss" which i believe is always pushed by Cramer the dancing ass-clown on CNBC :)

It's pretty hard to believe that the No#1 Stock Guru in America "in the eyes of the individual investor" is produced and directed by the same guy who did the Jerry Springer show.