August 24, 2011

Why Stocks Move 5 Pct In a Day

Show of hands, please.

How many of you saw Levi Leipheimer’s monster run in the big ring up the finishing hill at Crested Butte yesterday to take Stage 1 of the Pro Cycling Tour of Colorado?

We’re bound for Vail later to see a couple stages. Across all the hours in the saddle, we have yet to stand at the barricade and shout ourselves silly as the world’s greatest cyclists power by, their body weight tied up in massive quads. Few things are as exhilarating as a wild race on bikes.

Except maybe big moves in your stock. Yesterday, a half-dozen clients’ shares jumped 10% or more. Five-percent gyrations were routine. Remember, we said last week that if institutions reset hedges with options expirations 8/17-19, then no matter what nasty economic data hit the fan stocks would climb on relative value alone.

We have been told by the creators of our synthetic markets, a handful of academics, that automated market-making and the maker-taker model for serving up fresh, sizzling artificial liquidity would magically wash that volatility right out of your stocks.

How’s that working?

What to tell your CFO when your stock jumps five points in a day? Few think it’s rational. But market structure is making utter mockery of investment. Public companies should demand a change to rules that have remanded price-setting to machines. Let’s end the NBBO and the national market system. It’s not working. But you have to ask for that, issuers.

After all, what investor will participate in markets ruled by gyrations, gut-wrenching plunges and an air of unreality?

Why do stocks move 5-10%? Automated market-making re-prices stocks so that programs swing wildly. Risk managers re-weight assets without regard to price. Leveraged trading – equities plus options. ETF arbitrage.

Big price-setting forces for one small-cap that traded up 10.5% yesterday were Tradebot, Madison Tyler and Instinet. One high-speed automated market-maker named by blending “trading” with “robot.” A quantitative high-frequency proprietary trader. And a dark pool that ostensibly matches natural liquidity but which we find often serves those chasing intermarket arbitrage – buy here, sell there, simultaneously.

IR pros, what to do? Redefine IR success. We suggest you track Rational Price – the periodic points where investors assert themselves, which changes the machines’ behavior.

Set parameters for program trading, rational investment and speculation that are acceptable. You can’t eliminate speculation. But maybe 25-30% of your volume as speculation is fine. Aim to remain in that range with effective targeting and proper use of communication and information. Show management that you’re doing it.

Speaking of data, here’s your tidbit for the day, courtesy of the Securities Technology Monitor. Type in your company name here and see where your shares trade.

Bottom line, we get busy taking command of the data, or we get busy becoming irrelevant. As we say in cycling, it’s all about time in the saddle.

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