David White's  Instablog

Many people have said they would like the POMO schedule for the Fed. This is a copy of the recently released schedule. The market tends to go up on POMO days.

Many pundits are now saying it’s Risk On again. I take exception to this. First the economic data from the US, the EU, and China has indicated decelerating growth. The Fed has substantiated this. This means growth will be less than expected. It means downward revisions are coming. This would tend to make one think Risk Off.

More than this the major currencies that can be used for carry trades are not positive for a carry trade that would benefit US stocks. Currently the USD is weakening against both the Yen and the Euro. This means that if you borrow either of these to invest in something else, you could still lose money. If the Yen and Euro are both strengthening, you would likely have to pay back more when pay the money back. In other words the risk trade would be too risky.

If the USD is going down, you might not want to invest in US equities because they would effectively be going downward in foreign currency terms. Since the Fed has indicated that it wants more inflation, it will likely act to weaken the USD. This should scare foreign investors away as long as they think the USD direction is downward. Plus in the near term, the US equities markets are highly over bought. They are due for a retracement. This too should scare investors (even US investors) away until a reasonable retracement has occurred.

Naturally this situation is in perpetual flux. Still it would seem for the near term that it is “Risk Off” rather than “Risk On”. The singing by some that high flying tech stocks are "trading like it's 1999" (the dot com bubble) is a further indicator that there is significant reason to worry. The failure of major DJIA tech stocks to move up significantly with the high flying techs is further evidence that the "tech rally" is more of an HFT mediated short squeeze of highly shorted, over priced, over bought high flying tech stocks than a real tech rally. The major tech stocks (ex. INTC, CSCO, HPQ, MSFT) are normally not shorted appreciably. They have huge market capitalizations. Therefore they are much harder for HFT traders to manipulate upward. They are a good indicator if you are trying to determine the veracity of a purported "tech rally". This one appears to be "fake". Highly shorted, over bought, over priced techs such as BIDU, CRM, OPEN, NFLX all seem likely to fall from their HFT short squeeze induced highs. Financial sector stocks do not seem likely to take up the slack with the re-emergence of the EU credit crisis (Ireland this time), and the big worries about the real estate market. Risk Off.
 

HFT comprises 70+% of all trading in today’s markets. It’s importance is unquestioned. The HFT traders will as Adam Smith said so famously act in their own enlightened self interest. When you realize this, you should ask yourself , “how can the HFT traders make the most money?”

The best opportunity for HFT traders is popular, highly traded, highly shorted, high institutional ownership stocks. Why? HFT traders make great money when they can push a stock up quickly (popular stocks in sector rotations are targets too). They buy it. Then they immediately sell it for slightly more. They can repeat this process thousands, tens of thousands, or hundreds of thousands of times per day. If the stock is going up quickly, they can make several times as much money as they do for a slowly rising stock. This is because the difference between the buy price and the sell price is substantially larger, even when only considering a small fraction of time. If a highly traded stock has high institutional ownership, the actual float -- the amount of the stock people are trading -- may effectively be much lower than the recorded float. Institutions generally trade infrequently. This means that an analyst upgrade of the stock allows the HFT traders to push the stock up quickly, if they trade it in high volume. The HFT traders can simply trade it back and forth among themselves at ever higher prices, with occasional interruption from traders who are actually keeping the stock for more than a fraction of a second. If the stock is highly shorted at this time, some of the shorters will lose faith in their short positions as the stock goes up. They will add to the up volume themselves. Momentum and market emotion traders will add further to the up volume. My belief is that there is not huge collusion among the HFT in these actions. However, they recognize the scenario. They know by convention that it is an HFT setup. They all tend to take the same actions to move the stock up. The same scenario plays out on overall market moves upward. Most of the highly popular, highly traded, highly shorted stocks are high Beta stocks. On an obvious market push upward, HFT traders will act as described above.

The net result of all of this is that stocks become more over valued than they might normally. The HFT traders only own them for a fraction of a second at a time. They simply turn their programs off when they stop making money. The short term traders may benefit or may get hurt by this, but they should be aware of what they are doing. The buy and hold investor is the real victim. Much of the time that investor cannot buy the stock because it is too overpriced. Or if that investor does buy the stock, he or she may get stuck holding it as it crashes soon after the HFT trader walks away from it. The HFT trader does eventually walk away when the stock becomes too top heavy. The buy and hold investor can thank the HFT traders for making the likelihood of big losses even greater. Is it any wonder the individual investor is scared of this market? Even stop losses often fail to work well. The extra volatility induced by the HFT trading makes stop loss results questionable at best for a long term holder.

Still the HFT traders do create some opportunities. If you can identify the approximate top or bottom in one of these cases, you can make a lot of money going along for the ride up or down.