Daily State Of The Markets: The Brave New World Of Day-Trading?

Includes: DIA, SPY
by: David Moenning

Good Morning. Trying to gauge the message from the market action has been more difficult than usual over the past month. Beginning on March 19th the S&P 500's close flip-flopped from green to red and then back again each day for a record breaking fourteen consecutive days. After that, the bulls gained possession of the ball for three additional days (chalking up four straight green finishes in the process) and closed April 11th at an all-time high. But unfortunately, it's been largely downhill from there as we were then treated to two big down days, a big up day, two more scary down days, and then Friday's pop higher.

As far as price progress goes, the S&P finished Friday at almost the exact same spot it closed on March 11. Thus, I guess we could say that the market has been treading water and trying to make up its mind about what to do next for the past 29 trading days as the better-than-expected theme may have morphed into another spring swoon. Can you say, sideways ... or how about, uncertainty?

Friday's closing price was interesting for a couple of reasons. First, there was little in the way of a catalyst to trigger the move higher. As such, the bulls contend that the recent selling has likely come to an end. Although one day does not a trend change, another positive factor the bulls are pointing to is the fact that Friday's bounce occurred exactly when and where it needed to.

(Click to enlarge)

As you can see in the chart above, Friday's low (a) once again touched the uptrend line that's been intact since mid-November, (b) once again tested (successfully) the 50-day moving average, and (c) once again tested (also successfully) the important support zone at 1540. And to hear the bulls tell it, the combination of the fact that there no catalysts and a perfectly timed rebound means that a rally phase is likely to ensue.

However, before you get too excited, we should note that although the S&P bounced on cue, the venerable index still has important resistance (the horizontal line drawn on on the chart) it will need to plow through if the bulls are to resume control. So, given the market's propensity to have no memory from one day to the next these days, the bear camp might have a little something to say again here sometime soon. This is especially true given that earnings from some pretty big names have been downright crummy of late.

Speaking of a market that has no memory and a habit of flip-flopping; I'd like to offer up a possible explanation for the action. However, before I begin I should disclose that this is just one man's opinion of the way the market might be working these days.

I recently had the pleasure of participating in a live webinar with the gang at Benzinga and Marketfy where HFT was the topic of discussion. While I was a panelist in the discussion talking about the effects of HFT from a money manager's perspective, I learned a great deal from the other two panelists, who were both experts in the HFT field. What was cool for me was getting to spend 30 minutes talking to Hiam Bodek (the author of The Problem of HFT - which is an exceptionally technical series of writings on the subject) one-on-one about the impact and the state of HFT before the webinar began.

The key takeaways from the webinar and my chat with the two experts were: (a) HFT is becoming more crowded all the time, (b) the practice is becoming significantly less profitable (GETCO's HFT profits were down 80% last year), (c) the NASDAQ exchange, in Hiam's words, has "cleaned up its act" in terms of allowing predatory HFT trades, and (d) that electronic "speed trading" isn't going away any time soon.

It's the last point that is the basis for my thesis about the market's tendency to be up one day and then down the next. You see, if you have the right tools including a high-powered supercomputer, a micro-wave data feed that operates at the speed of light, and the ability to execute trades directly, your trading/investing time frame can be expanded dramatically. Instead of a 1-minute chart of the S&P 500 or SPY, you can utilize a millisecond chart. So, instead of 1 bar for each minute of the trading day, you have 60,000.

Instead of the 390 points on a 1-minute chart for each trading day, you have 23.4 million. Thus, you have the opportunities to "play" a trend-following game during each and every day - as well as the ability to go home "flat" and have no overnight risk. In other words, being able to work on a millisecond basis means that every single trading day brings countless opportunities to profit on the intraday trends.

Frankly, I can't fathom even the concept of the speeds involved. But I know that trading is trading and that trend-following can and does work well. So, even if you were following trends of the market on a 1/10th of a second basis, you could probably do pretty darn well.

So ... if my thesis is correct, there are a handful of folks that have the tools, the know-how, and the money to play this game. And if you can profit from moves that would normally take place over several years (or more accurately, decades) each and every day, every opening bell is a brand new ball game. Welcome to the brave new world of day-trading.

The idea here is that the trend-following algos have the ability to create a self-fulfilling trend in the market. Thus, once a micro-trend move begins, the trend-following algos race to all jump on ahead of the next one. Then when the trend begins to reverse, yep, you guessed it; they race to jump out. In my humble opinion, this is how/why the market moves 5-7 points in 5 minutes on no news so frequently these days. Strength begets strength at the speed of light and vice versa.

So that there are no misunderstandings, this is simply my opinion of what could be happening within those whirring machines that the big-boys on Wall Street and Chicago have. Humans can't play this game because it simply unfolds too fast. Frankly, I'm jealous as I would love to be able to play this game. Maybe I'm all wet here and maybe such a trading game doesn't exist. But since technology gets cheaper every year, maybe we'll all be trading stocks faster than we can blink sometime soon.

Turning to This Morning ...

Stock futures appear to be reacting positively to (a) word that the G-20 is not going to stand in the way of Japan's massive QE program, which is causing the yen to plummet, (b) the reelection of the President in Italy, and (c) a strong rebound in gold prices. However, Caterpillar's reduction in their guidance is keeping a lid on the enthusiasm at the present time.

Pre-Game Indicators

Here are the Pre-Market indicators we review each morning before the opening bell ...

Major Foreign Markets:

- Shanghai: -0.12%

- Hong Kong: +0.14%

- Japan: +1.89%

- France: +0.47%

- Germany: +0.72%

- Italy: +2.03%

- Spain: +1.50%

- London: +0.44%

Crude Oil Futures: +$0.39 to $89.60

Gold: +$37.70 to $1433.30

Dollar: higher against the yen, euro and pound

10-Year Bond Yield: Currently trading at 1.720%

Stock Futures Ahead of Open in U.S. (relative to fair value):

- S&P 500: +3.95

- Dow Jones Industrial Average: +35

- NASDAQ Composite: +8.79

Thought For The Day... Quality means doing it right when no one is looking. - Henry Ford

Positions in stocks mentioned: none