Tag Archives: flash crash

The AP Hack Crash Facts

The first article of mine that was picked up by the Sandusky Register was written in the late afternoon on May 6th, 2010 as I put together the notes for our clients explaining the “Flash Crash,” what and how it had happened. Tuesday afternoon the Twitter account of the Associated Press was hacked and the following tweet was sent from their account, “Breaking: Two Explosions in the White House and Barack Obama is injured.” The stock market plunged one percent in less than three minutes. Within five minutes, it had returned to its previous level. Let’s take a look at some of the issues this brings to the trading table.

The market is always the boss. Traders at their desks can employ a thousand models suggesting the market should move in a certain direction. However, anyone sitting at a trading desk or on the trading floors will tell you, when you’re in the market, you’re playing the market’s game on the market’s terms. Therefore, when prices move rapidly and unexpectedly against a trader’s position self-preservation kicks in and the trader exits the position – THEN searches for the catalyst that suddenly turned the market against them. Rule number one in trading is self-preservation.

This mentality is best evidenced by protective stop loss orders that automatically trigger when a market moves beyond the trader’s loss threshold. Meanwhile, another group of traders prefers to exercise their own orders in which case, they’ll manually enter their order as the market exceeds their pain tolerance. These two groups were the ones hit with losses as they raced each other to the bottom in an attempt to unload their positions. For the record, our protective sell stops were also hit on the way down. Think of it as a bank run. There’s always enough cash to cover the withdrawals of those at the front of the line.

The traders most deeply affected by the sudden downdraft and ensuing return to normalcy were the day traders and the high frequency traders. Our position in the Russell 2000 stock index yesterday was a day trade on the long side of the market based on follow through from Monday’s outside day. Monday’s outside day is defined by falling through Friday’s low only to turn around and close above Friday’s high. This is a very bullish signal when coming at the extreme of a recent move. This outside bar combined with some other analysis put us on the long side. Protective stops had been placed and adjusted throughout the trade leading to a small win. In this case, not placing a protective stop would’ve been much more profitable but, what if the Associated Press had been right?

Once the market began to sell off, high frequency traders joined in the game. High frequency trading is day trading without the human input. Humans write the computer programs and the programs being fed the live data stream automatically executes the trades at the exchange. These programs have replaced the scalpers you’re used to seeing on TV in the trading pits yelling at each other. High frequency trading gets a bad rap for increasing market volatility but gets no credit for providing market liquidity. Liquidity is THE most important aspect of U.S. financial markets. Liquidity is why we are the global financial capital. Without liquidity there is no one to take the other side of the trade. Without liquidity there is no market.

Finally, let’s put it all together. The market was quietly trading up about half a percent on light volume when the AP’s tweet was posted. Volume exploded by a factor of 10 as the market declined. The volume surge that was taking day traders and tightly placed protective stops out of the market was being replaced by high frequency trading programs that are ALWAYS called to action by volatility and volume. Ironically, the same high frequency trades that made a killing during the flash crash actually got burnt by the, “Hack Crash” as the market returned to normal faster than newly initiated short positions could be covered at a profit.

There is little predictive value in the events of the, “Hack Crash.” However, there are some key takeaways for traders. First is the importance of protective stops. One never knows what could happen next. Second, verify news reports. I have the AP’s iPhone app, which alerts me to breaking news and had no mention of the tweet until after the fact. Therefore, the corporate disconnect between Twitter and their app was my first clue it was bogus. Finally, cut the high frequency traders some slack. Their programs are based on risk and reward just like our own and the liquidity they provide in times of dramatic events is exactly what allows us to get out of the market and keep some powder dry until the smoke clears.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Long Only is Not Diversification

The cycle of bubbles will continue. Assets will always chase higher returns. The markets in the United States that are available for the general public to allocate funds to are mostly, “long only.” The general investing public is provided with a number of choices as to what they can buy to invest in. We’ve seen the cycle rotate from sector to sector within the stock market or, between stocks and bonds. Arts, antiques, cars and real estate have all had their periods when ownership was lucrative. Fortunately, being able to short sell commodities with a phone call or a mouse click is much easier than selling a car or a house when the market turns.

Lately, commodities have taken center stage as the thing to own. We’ve seen it in gold and oil and more recently in grains, agricultural commodities and stock index futures. Thirteen commodity futures markets set new records for commodity index funds’ open interest in 2010. Over the last few weeks, we’ve seen commodity positions being transferred from the index funds to the small speculators. This transfer of positions from index and commercial traders to small speculators typically occurs near the end of a protracted move.

Bubbles are created through the over popularity of an asset class. The speed of the bubble cycle increases when leverage is involved. We’ve seen this in the stock market crashes of 1929 and 1987 and as recently as May of 2010 in the, “Flash Crash.” The world is still unwinding the over leveraged global mortgage debacle. The new vogue in leveraged assets has been the creation of commodity funds. Commodity funds have provided a long only investment entry into the futures markets for the novice investor. These funds have gone from non-existent to more than $370 billion in equity at the top of the first commodity bubble in 2008. We have since surpassed that total.

The commodity index fund market is no different than the mortgage backed security market was when it was marketed to the public as a way to, “ratchet up returns while providing diversification.” Investment office salespeople need products to sell. These products are usually a good idea at the beginning but, become overpopulated and over valued as a result of a good idea turning into the next big thing and eventually falling of their own weight.

I’ve suggested that the global economy is due to slowdown. Furthermore, the governmental response to the economic crisis has done little to right the long-term path of our economy. Over the last three years, the stock market is higher, reported unemployment is below 10% and gas prices have stabilized. However, it has taken a Herculean effort by the government, which has dropped the Federal Funds rate from 4.5% to 0, expanded the Treasury’s balance sheet by $1.5 trillion and printed $1 trillion on top of that just to bring GDP and our population’s complacency back to where it was at the end of 2007. This is the Government’s form of a leveraged asset, which is also becoming overvalued and overpopulated and is in peril of falling of its own weight.

Diversification among long only assets will not provide the type protection people expect when these markets begin to falter. Over the last five years, there have been 13 weeks when the S&P 500 closed more than 5% lower from week to week. Conversely, there has only been one week in the last 5 years when bonds have closed that much higher. That was the flight to quality run of November 21, 2008. That was the height of the panic of the meltdown. The truth is, when liquidation hits the market, it tends to cross all classes. These are the days when the commentators lead in with, “There’s a lot of red on the board today.” Gold, copper, oil, grains, cattle, etc. have all averaged at least as many large losses as the stock market. Forty percent of these losses coincided with large stock market declines. In this day of instant everything, instant liquidation to cash is only a few mouse clicks away in the futures markets rather than end of day fund settlements.

The futures markets were meant to be traded from the long AND the short side. Commercial traders use this feature to manage their own production and consumption concerns. Individual traders can also have this direct link to the commodity markets. The liquid flexibility of the futures markets allows individual traders to hedge their holdings through the direct use of short selling just as it allows leveraging of outright exposure on the way up.  The right brokerage relationship can make them the perfect tool in the hands of the individual managing their own portfolio as opposed to the long only fund salesman seeking out the next tool in the general public.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

A Counter Trend Thought on Gold

The gold market has had quite a climb since bottoming in December of ’08, rallying nearly 50%. I think a solid case can be made that this market is due for a correction. Furthermore, given the variables in play, the first leg of the correction could come hard and fast. As many of you know, I tend to place the general direction of my trades in line with commercial traders. Over the course of time, this has been a proven strategy. However, there are times when it would be foolish to blindly follow a given position when so much evidence is clearly stacked against it. This is a case when a choice should be made- AT MINIMUM – to take either one of the following actions. First, avoid buying the pullback. New long positions should be avoided. Second, crank up protective stops on existing long positions. Investors who have been long the gold market have done well. Whether in the physical gold market or the futures market, those profits should be protected. For those in the physical market, now would be a great time to use commodity futures to lock in profits without having to off load your physical holdings.

The most obvious caution flag we can see is that gold is testing its weekly trend, now coming in around $1170. From a purely technical standpoint, that should be enough to get your attention and cause protective measures to be taken for long positions.

The daily chart shows that gold was unable to make new highs during the “Flash Crash,” and that the recent highs at $1203 are providing the top side of a consolidation level that, when broken will take out the existing trend. The consolidation pattern over the last six trading sessions suggests a fall to $1148 is imminent. Activation of this short term pattern would be a clear violation of the previously mentioned weekly trend.

A deeper look shows divergent technical and inter-market analysis that suggests the gold market is top heavy here. The final chart shows a large build in commercial positions through  June and so far into July. Typically, this would be enough buying to push the market above the highs at $1220 and make a strong argument for new highs above $1270. The fact that the market’s reaction has been oblivious to this is a clear warning sign of impending weakness. The lack of a positive response to the commercial buying via the commitment of traders report is clearly visible in the blue line of the last chart as each successive rally attempt has shown less fervor than the last.

Finally, a brief survey of macro- economic analysis shows that the interest rate markets have no pending fears of inflation. The stock market shows the July lows may have been a short trap and market crash fake out. And lastly, the Dollar’s pull back is to be expected after the run up its had and we are already seeing new buying come in to slow its descent.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.