December 7, 2010

Why IR Pros Need to Love Some Math

Scheduling note: I’m in Miami Friday for a panel discussion on trading realities for the NIRI Senior Roundtable. Hope to see you there!

Today is the anniversary of Pearl Harbor. Near the end of WWII, my great uncle, Jack, was one of 316 sailors from 1,200 aboard the USS Indianapolis to survive its sinking and days in shark-ridden waters in the south pacific. Tough fellows, those guys.

On that happy note, let’s turn to everybody’s favorite topic: math. Click here for an example of math in action, a chart showing the spot market for the US dollar, called the DXY, and the Dow Jones Industrial Average, the past three months. The two juxtapose like the mirror image of a mountain in a still lake on a clear day. Wherever one goes, the other is equally opposite.

IR pros, this should hearten those of you wandering the Wilderness of Answers About Trading. Why? If math is so measurable in one place, it’s equally measurable in others. Measures are answers.

I traded notes with the IRO for a megacap – obviously not a client – who lamented, “There are no answers.”

To quote the French, “Au contraire.” Answers abound. And we have math to thank for that. All trades must meet at the National Best Bid or Offer. That’s a math equation. All broker-dealers must hew to rules on reporting trades and meeting best execution standards. More math. Algorithms, which are math equations, drive, oh, call it 98% of equity volume. The entire US trading environment is predicated on technology and rules built around math.

What’s unpredictable is human behavior. Try tracking a schizophrenic (no offense to any schizophrenics). Now that’s challenging. But math? It’s just equations. This is also why speculative traders look gleefully at today’s markets and rub their digits together, little zeroes and ones full of anticipation.

But we can see them getting excited, just as they did Dec 3. Across the markets Dec 3 came a rush of speculative excitement. Perhaps it related first and foremost to the math we noted above – expected weakening of the US dollar (on ebbing Euro fears and the Germans readying to sacrifice more of Deutschland to the greater, weaker good) and its correspondent boost in US equities. Whatever the case, speculation is driving stocks, and we can see it.

If we can see it, so can you, and even more specific things. Say for instance, how program trading changes in this particular stock in the technology group, or how thoughtful investment dollars, differing from macro trades around, reflect value-buying in an office REIT. Or how month-end moves by quantitative institutions in a small-cap technology stock, evident in a big lump of volume in a predictable place and smatterings elsewhere, attracted value buyers, thus also revealing the stock’s rational price (where thoughtful investment dollars compete with other behaviors).

IROs, there is a place for math in your program. It should be simple. We recommend basic weekly “market structure” (behaviors behind price and volume) measures. Quantify crowd behaviors with program trades. Speculation through tracking volatility executions. Rational activity by observing some firms who execute trades but can’t speculate well or run big programs (the lack of this latter illustrates how widely math has been embraced in trading markets).

We’ve already figured out how to do it. If you want to do it yourself, as I used to do in the IR chair, look at your trading activity. It need not be perfect. The same mathematical rules apply across the National Market System. Start measuring the data in comparison to what you say or do, and when you say or do nothing. Compare.

Yes, math is a four-letter word. But so is love. And maybe the IR profession needs to love some math, and stop looking for love in all the wrong, old places.

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