We assume investors know how markets work. What if they don’t?

Patrick Armstrong, new president of the Securities Traders Association of New York (STANY), told Traders Magazine yesterday that the buyside has been absent from the market-structure debate.

What debate? If you joined the IR profession in the past 15 years, you may be unaware that stocks today trade radically unlike any other time in the general history of capital markets. It’s not a technology question. Things change. Machines convert human processes to automated ones. That’s normal.

When steamboats flourished on the Mississippi River, what had been hard – rowing upstream – became an easy ride. Travel took on an aspect of leisure. It moved from essential to enjoyable (air travel has gone the other way, as I was reminded yet again flying yesterday from Denver to Newark). It was still travel, though.

What’s the purpose behind trading stocks today? Don’t listen to what somebody tells you. Look at the data – which you do if you use Market Structure Analytics. The data say that the purpose of trading markets is to move things around for profit. That’s 85% of your volume.

If the exchange listing your shares had told you that the fees you pay would give you access to a bunch of short-term traders moving your shares around so the exchange could profit on data revenues, would it have changed your view of the market?

“I want [the buyside] to tell me their opinion on the direction of our market structure. I believe that those who are for the status quo, those who say everything is fine, are the ones to be wary of,” Armstrong said. Continue reading →

I dare you.

Ever say that as a kid? “I’ll give you a dollar if you—” (fill in the blank)

Last week the SEC approved a plan by the NASDAQ for sponsors of ETFs trading less than a million shares daily – 93% of ETFs – to pay $50,000-$100,000 annually to market participants if they dare to trade any of these ETFs more aggressively.

We opposed this plan because it allocates dues and fees specifically, not equitably as the Exchange Act requires, and it promotes statistical arbitrage – trading securities for spreads. That’s harmful to buy-and-hold investors and the issuers who seek them out.

The NASDAQ argued – successfully – that stimulating trading in weak ETFs unattractive to automated market-makers will shrink spreads, boost volumes and benefit investors.

Yesterday at TABB Forum, a news site for the trading community hosted by influential consultancy the TABB Group, Stephen Bain from RBC Capital Markets wrote a piece called “The Hidden Cost of Tighter Spreads.” RBC studied trading before and after spreads between the best prices to buy or sell tightened through decimalization and automated market-making.

Bain wrote: “Our initial analysis documents a marked increase in short-term price gyrations for individual stocks, which have effectively doubled from pre-2000 levels to present. This finding represents a significant increased cost for investors – entirely contrary to claims that lower execution costs now prevail.”

We arrived at similar conclusions. The average US stock has Total Intramonth Volatility (TIV) of roughly 40%, calculated by subtracting the low price from the high price each day, dividing by closing price, then tallying those over 20 trading days. Continue reading →

Is it diluted?

That’s what everybody wants to know about the market. Are gains for broad equity measures, seemingly epic like my skiing Saturday at Copper Mountain, real or watered down?

That’s actually not our story this week. But we’re so fascinated by what market structure shows that if you huddle in here we’ll share observations. The dollar declined when Japanese Prime Minister Abe said Monday that either the Bank of Japan creates inflation or the government will rewrite its charter. That means more currency devaluations for everyone (if your money buys less tomorrow than it did today, that’s a devaluation whether called one or not).

So stocks rose yesterday. Also helping stocks, money was hedging at options-expirations Feb 15. When investors hedge they tend to invest more funds. Sentiment is okay, too, finishing last week at 5.38 (on a 10-pt scale), up from 5.05 to start the week. Yesterday it was down to 4.71, by far the lowest level all year.

All over, short volumes are down compared to long volumes. That’s a loaded message. Higher short volumes mean more competitive markets. But lower short volumes also mean demand for wholesale short positions is down and shorts are covering. Which is good.

Talk about mixed messages! Investors want stocks to rise but are wary. Lower overall short-interest (bullish) and some short-covering (bullish) also means money is less prepared for the unexpected, and that markets aren’t as competitive as they should be when prices are rising. Pray for no surprises or we’ll have a monumental down day.

Which brings us to our story. Beam, Inc., distiller of Maker’s Mark, said last week that to stretch its oak-aged bourbon it would cut the alcohol content. Drinkers recoiled in horror and disgust. They’d rather do without than do with less for the same price. Beam backed down. Continue reading →

Having never gone to a Neighborhood Pumpkin-Carving, we were wistful when squirrels promptly devoured the face off our finished product (marked “easiest” in the booklet of pumpkin-carving patterns we purchased). Ah well. What some consider a jack-o-lantern others see as a meal.

Speaking of scary, for those keeping record we note more currency-driven events to explain to your executives. First, the European Central Bank last week threw down the red carpet for Greek lenders, so the dollar dived and stocks soared on changes to perceived risk and anticipated further global currency-printing. On Halloween, Japan intervened to weaken the yen by buying other currencies, so the dollar strengthened (less supply, same demand) and markets plunged. On Nov 1, fear of setbacks on the Greece deal drove risk managers back to the dollar, pushing it up and stocks down more.

US markets should be proxies for fundamental value and forward multiples of collective corporate cash flows. Not meters for currency fluctuations. Happy Halloween.

Speaking of meters, there is Tom Peterffy, immigrant, billionaire, and architect of automated trading. Peterffy ranked 236th on Forbes’ list of the 400 richest in 2009, fruits of long labor revolutionizing how stocks trade. Peterffy, founder of Timber Hill and Interactive Brokers, pioneers in automated multi-asset-class electronic trading, believes automated trading goes too far. Continue reading →

Observe. Orient. Decide. Act. OODA.

This is how Pipeline Trading describes its predictive analytics for helping buyside customers identify large-block trading opportunities.

For those of you who missed the news that rocked The Street this week, Pipeline, a dark pool, was fined $1 million by the SEC for misleading clients about the nature of its liquidity.

Were you harmed? Check to see if your shares trade at Pipeli—

Oh. You can’t. It’s a dark pool. You don’t know if your shares trade there unless Pipeline’s orders route to your listing exchange.

Of Pipeline, SEC Enforcement Director Robert Khuzami said in a statement: “Investors are entitled to accurate information as to how their trades are executed.”

Pipeline offers a platform where institutional customers like mutual funds can find “natural liquidity,” or real orders from other buysiders. What’s more, Pipeline provides execution algorithms that mimic how high-frequency traders try to project price and volume in order to place profitable trades ahead of moves. If the buyside can beat HFT at its own game, then instead of being victimized, it can also generate alpha – market-beating returns on trades. Continue reading →