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Joseph Stuber
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Joseph has been an analyst, investor, and student of economic theory; money and banking; and statistical methods for evaluating and implementing risk/reward trading algorithms since 1972. Joseph is also an occasional contributor to financial publications and his essays are frequently cited by... More
  • An Asset Is Worth What A Buyer Will Pay When You Try To Sell  5 comments
    May 1, 2013 2:11 PM

    True price discovery occurs at that point where you decide to sell an asset. Until that time you really don't know. And what its worth is a supply/demand function. The greater the supply the lower the price and of course the inverse is true - the lower the supply the higher the price.

    At equilibrium there is a balance between buyers and sellers of an asset. If the asset is perceived as desirable the supply will contract and the price will climb. The inverse is true if an asset is deemed less desirable in that the supply for sale will increase and the price will decline. On occasion a very sudden and unforeseen event shifts the perception of desirability from very desirable to very undesirable.

    Nassim Taleb describes such an event as a "Black Swan". The "Black Swan" causes an instant shift in sentiment that produces a very high supply of stocks for sale at that single point in time where the event becomes known. On occasion the "Black Swan" event is nothing more than the result of a high percentage of owners of an asset deciding to sell that asset at the same time.

    The 1987 "flash crash" wasn't the result of anything more than that - simply an unpredictable and unforeseen decision to sell a large quantity of stock in a very condensed period of time. Any explanation for why that particular point in time is relevant, significant or any different than the days preceding or following the sell-off is nothing more than an attempt to make sense out of an event that didn't make sense. I remember that day as clearly as I remember the day President Kennedy was assassinated. Here's what the chart looks like.

    (click to enlarge)

    The single most important consideration for investors today is the fact that the probability of a repeat of the 1987 crash is very, very high. This warning is relevant to small investors but probably not so much so to large investors. The truth is that large investors are stuck and there is little they can do to mitigate the damage at this point. Here's my point. A large investor who seeks to take profit will find that the price posted isn't really the price at all - at least the price he will get for a large block of stock. The reason - there isn't an equilibrium balance between those who want to buy and those who want to sell. You want proof of that point. Here's Google. The second chart is Symantec.

    (click to enlarge) (click to enlarge)

    The Google "flash crash" produced a 3% drop in price based on the sale of 57,000 shares and Symantec fell 10% on 500,000 shares. Just to put the 500,000 share order in perspective the top 10 institutional investor's holdings of Symantec range between 58,417,616 on the high and 12,558,686 on the low. 500,000 shares is a big order but relative to the size of the large trader holdings it is not that significant.

    In a liquid market where some degree of buyer/seller balance existed that trade would have moved the market a little but not 10%. If you think that stocks are clinging to all time highs because the economic outlook is so rosy you are wrong. They are clinging to all time highs because the so called "smart money" doesn't know what to do. They can't sell as there are no buyers - at least buyers that can absorb the "smart money" orders - that is to say large orders. By the way the idea that large traders are also "smart traders" is a bit of a misnomer.

    I want to share this excerpt with you from an article on Zero Hedge the other day. The author's cynical style serves a purpose and also tends to inform us of what we really already know - stocks are simply not responding to the economic metrics that are signaling a rapid deterioration of the economy.

    Macro Collapse Pushes S&P 500 To New All-Time Nominal High And Close

    "Horrible" PMI, no problem; just add it to the list of macro data that has missed significantly in recent weeks. Bloomberg's US Macro index has utterly collapse (d) in recent weeks - now at its worst level in 7 months but apparently if good is good, bad is better, and totally shitty is absolutely awesome."

    There is a reason that stocks are clinging to all time highs in the face of rapidly deteriorating fundamentals and it is no longer confidence in the Fed. We've seen a few attempts to exit the markets in recent days and the truth is there are no large scale buyers. Think gold - as I write this gold is once again accelerating to the downside. We are down $30 at the moment. Here's a look at the chart with my standard deviation grid overlay.

    (click to enlarge)

    I've never seen a sell-off that pushed a market that far below mean. Gold was so oversold that the chart needed to catch up - therefore the spike higher. Today's price action suggests that we've finally corrected the severely oversold condition on gold and are prepared now for the next leg down.

    Now think S&P 500. A move to 6 standard deviations below mean on the S&P 500 would push the price to 1233.00. Here is what the chart looks like current through today with the 6 standard deviation price added for effect.

    (click to enlarge)

    That can't happen you say - well there is sure a lot of empirical support for the fact that it can happen. A little advice and I will close - the risk/reward at these levels is atrocious and the odds of a slow and orderly descent are not high. Don't expect a big warning this time as it would appear a "flash crash" is imminent.

    Disclosure: I am long UVXY, TECS, FAZ, TZA.

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Comments (5)
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  • tampat
    , contributor
    Comments (1386) | Send Message
    More a matter of when not if this happens.
    1 May 2013, 04:23 PM Reply Like
  • Bill J
    , contributor
    Comments (24) | Send Message
    Good stuff all. Allow me to play the devil's advocate and see where this might lead. It is in the best interests of the Fed and Treasury to see the dollar value of gold decline. Strike fear and terror into the hearts of those seeking security in a precious metal is not what they want right now. Over night multiple thousands of sell contracts simultaneously hit the wires tripping stops and gold goes down hundreds of dollars. Mission accomplished. These flash crashes, Semantics, Microsoft a week or so ago, equities that went down too quickly, bounced back too quickly. And too easily accomplished with clever programming of HFT methods. Perhaps. These are just clever ploys to allow the unscrupulous to harvest a few more buck$ from folks trying to play by the rules and get a bit ahead in hard times. Drive the price down by selectively offering sell orders, orders that are instantly withdrawn. When that equity moves down suddenly having tripped many stop-loss positions, just as instantly buy them back at the artificial low price.


    It is in no one's interest among "The Powers That Be" to see the SP500 crash down 6 standard deviations down, not now, not ever. Taibbi writes eloquently about how pretty much everything can be manipulated. Why should anyone expect a sudden crash now? Historically the '87 crash happened in the infancy of computer trading methods. That happened in a time before QEternity, POMO, before the emasculation of the SEC and Department of Justice, before Too Big To Fail. Might it not be argued that "this time is different?"
    Just asking.
    (Yeah I'm long FAZ, TZA, etc)
    2 May 2013, 07:57 PM Reply Like
  • Bill J
    , contributor
    Comments (24) | Send Message
    I’ve been thinking and reading a good bit about what I wrote earlier and would like to offer an additional comment, a reply to me. Readings included the bit by John Mauldin about chaos theory and grains of sand from his book “Endgame”, reprinted recently on his blog site “Thoughts from the Frontline”. One never knows when that final grain of sand, one too many, will trip a collapse. Thinking about the collapse of a medium sized bank in Austria thought to have been the trigger for the depression of ’29-’32, thoughts of a little Dutch boy ( and finally thinking about the global computer network.


    One should never underestimate the power of pathologically greedy people who strive for power and wealth. Creating tools that only they can wield and eliminating controls that might limit their action gives them formidable strength. Not unlimited, simply formidable. I suspect if the US were an island with no connections to anywhere, such powers might capable of control for a very long time.


    One has only to read of the history of the collapse of the Weimar Republic in Germany to realize that their problems in large part ended at the boarder. Neighboring countries looked on in amazement as Germany self-destructed via the printing press even as Havenstein was thought a hero by German citizens for printing as massively as he did to “save the country.” That probably cannot happen again. Computers, high speed communication, cabals of central banksters working together have assured us that we are now a global community, no more islands of economic nonsense. Everyone has skin in this game. As JS has pointed out via a ZeroHedge article, fundamentals are rapidly deteriorating on a global basis. Twenty horrid numbers are trumped by one “positive” employment print, markets fly—for now. If it were just the US they could probably continue to fly but it is not just the US. There are too many centers of increasing weakness, too many holes in that dike, not enough fingers to plug them all. Someone in Japan or Portugal, or Luxemburg or Slovenia or ? will flip. Black swans ignore borders. As JS has pointed out many times, there is nothing by air underneath US indices, no fundamental strength and the global scale of weakness is beyond the reach of any printing press.


    It is only a matter of time and I suspect time is running out.


    4 May 2013, 09:53 AM Reply Like
  • Joseph Stuber
    , contributor
    Comments (1740) | Send Message
    Author’s reply » Bill


    I like your reply to your own comment. All good points.


    5 May 2013, 01:18 PM Reply Like
  • vladkri
    , contributor
    Comments (254) | Send Message
    Here is an idea. Find a stock with high concentration in few big boys' hands, relatively flat current chart and put perpetual buy order at -3SD. Since we expect the crash being "flash" rather than demolition, should be quick money. Be sure to remove the order around earnings dates. By the way, as a developer I can assure you no such programming exists that accounts for all conditions. In fact, the more "clever" software is, the bigger bug lives in there. Considering lack of usual prey (the retail investors) HFTs are hunting down each other greatly increasing probability of the crash due to some sort of feedback loop. On the other hand, the favorite defense of the HFT boys seems to be just flipping the switch. Without good old market makers, just as JS was saying, there is no bottom under the markets. My 2c.
    2 May 2013, 09:20 PM Reply Like
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