Editorial Note: This Market Structure Map first ran June 29, 2010. It’s reprinting because Tim Quast is following the lead of congresspersons by taking a “fact-finding junket” aboard a sailing vessel off the coast of Belize. It’s in the public interest.

Oscar Wilde said that illusion is the first of all pleasures. Of course he also wrote that anyone who lives within his means suffers from a lack of imagination.

Buttressed on either side with those brackets about illusion and means, let’s look today at what’s afflicting our market and why some institutions like transient trading when others don’t.

Vanguard, an institutional investor focused on passively managed funds, supports high-frequency trading. George Sauter, CIO for the Vanguard Group, wrote in the firm’s comment letter to the SEC on market structure that high-frequency volumes reduce trading costs through competition and tighter spreads. He quantifies the benefit to investors at roughly 10% over a decade. A passive fund providing 9% returns per annum would deliver only 8% returns without HFT. Continue reading →

Isaac Newton posited 334 years ago in his third law of motion that mutual forces of action and reaction between two bodies are equal.

I wonder what he’d think of the relationship between the US dollar and equities, where this small action produces that decidedly unequal reaction.

After the Federal Reserve acted to shore up bank balance sheets by buying long bonds and mortgage-backed securities last week, the dollar trampolined and markets dropped like Newton’s apple.

Pundits blamed dismal economic data. Yet we saw money market-wide shifting from equities September 16 with quad-witching. Before the Fed offered a dim economic portrait. If money was reacting, it sure had a funny, proactive, organized way of showing it.

Today and Monday, the dollar weakened and stocks zoomed skyward in a Newton-flummoxing frenzy to reclaim paradise lost. How many believe this is rational investment behavior? If you do, there’s a solar-panel plant in California that might interest you. Continue reading →

Why are markets dropping like the thermometer at 8pm on Pike’s Peak?

Debt chaos, sour economic data, sure. We’re not market prognosticators, we track behavioral data. Under the skin of the news at market level, institutions shifted to managing portfolio risk about July 21. These events were observable. Algorithmic execution changed, and we saw what started it and what followed.

Large diversified asset managers swapped out of equities. That means they assigned the risk in portfolios to others through agreements that traded risk for safety at a cost. Why not just say “investors sold to manage risk”? It’s not accurate and it won’t be reflected in settlement data.

Of course, hedging produces a range of consequences too. Those underwriting hedges themselves hedge the risk they assume. That prompts speculating in whatever instruments are being used to hedge the hedges. The idea is to offset every point of exposure – like double-entry accounting, a credit for every debit.

Consider the Treasurys market – the one in peril till today. Primary dealers ranging from Banc of America to Goldman Sachs make markets in Treasurys. Average daily trading volume in Treasurys is more than $500 billion. Bond trading in total in the US averages more than $950 billion daily and nearly 80% is government securities.

Continue reading →

We’re back from NIRI National!

Orlando sweltered like you’d expect a swamp in central Florida in June might. We heard 1,300 were on hand, up triple digits from last year. There were new faces in the crowd and new vendor names, though big ones were absent too because exhibit costs go up while things like annual reports and total public companies decline.

We were tethered to the booth mostly but I sat in on the session about how equity markets work. Rich Barry from the NYSE, John Adam of Liquidnet, and Brian King at BATS paneled, and well. Our client Moriah Shilton at Tessera moderated like a pro.

The room was packed to standing-room-only. In the two years since I sat in Moriah’s seat on the stage, how markets work and what to do about them continues to populate the thoughts of IR folks, clearly. They streamed to the mics throughout with queries.

Karen and I nudged each other and shook our heads at this one: “How can we understand where our shares trade and for what reason?” Continue reading →

It’s a question that burns in the minds of IROs daily. No, not that one. This one: “Will an ISO post to the Nasdaq if the TIF modifier is one other than an IOC?”

Sentences like that are why alcoholism remains widespread. It’s also the reason IR folks don’t want to know how markets work. Too complicated.

Yet if we’re brutally honest, we know we should understand more. I mean, you can’t claim to be a great Yankees fan and not know the rules of baseball.

The sentence above from Nasdaq Reg NMS FAQs says: If I’ve chosen to fill my order up to the designated number of shares at a set price without leaving the Nasdaq to check for better prices elsewhere, suppose the time to complete the order is something besides “immediately or forget it.” Will that order be accepted at the Nasdaq?

This is how markets work. If you want homework, Google “Rule 611 Reg NMS.” Continue reading →