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Even when they’re profitable every day, high-frequency traders aren’t making much money

Virtu Financial—one of the world’s largest computerized trading firms—made money every trading day last quarter. The problem is that it made less of it than in the past, as volatility in the financial markets has dried up in recent months. Big price swings are good for high-frequency trading strategies, as machines can swoop in and take advantage of market shifts.

While many high-frequency trading shops are secretive about their results and plans, Virtu is listed in New York, so its required updates provide a view into the state of the industry. The company’s profit from trading fell in just about every category last quarter, with net income from currencies and commodities taking the biggest hit, each declining some 30% versus the same quarter last year. The company’s share price fell by 8% in early trading.

More here – Quartz

What’s it like to lose £350m?

In 2009, shortly after the global markets had suffered their worst crisis for 90 years, Alexis Stenfors was working as a currency trader for Merrill Lynch in London. With 15 years’ experience, he was good at his job and he prided himself on his ability to read the markets. His view was that the whole financial system was going to go “belly up”. That was what he was betting on.

And boy did he bet. He took increasingly extreme positions and when they failed to return dividends, he covered up losses in his trading books that he estimated to be around $100m (£78m). Then he went on holiday to India. Stenfors didn’t realise it at the time, but it was the end of his career as a trader, and the beginning of his notoriety as a rogue trader. Merrill Lynch later announced that his actions had resulted in the loss of $456m (£356m).

He lost his job, the media left his reputation in tatters and he was banned from the City for five years. Now he has written Barometer of Fear, a book about his experiences. Or rather, he has written a book that touches on his experience, but is rather more concerned with institutional wrongdoing, such as the Libor scandal. It’s a strange confession-cum-critique in which the author still seems unable to explain his own role.

More here – The Guardian

PS: One thing very good traders have is insight into themselves – it sounds as if Stenfors has little or no insight into his own motivations and hence his reasons for blowing himself up.

Stock Analysts’ Biases Are Showing, a Study Finds

Turns out birds of a feather flock together on Wall Street, too: Male stock analysts tend to write more favorably about public companies headed by men than about companies led by women. White analysts favor firms run by white chief executives. And Republicans and Americans in general prefer companies helmed by people like them.

It is called group bias, and four academics have nailed down evidence that it exists among stock analysts, who are paid to guide investors’ bets with hardheaded, rational views of companies’ prospects.

As a result, earnings surprises of firms headed by female, foreign or Democratic CEOs are systematically upward biased, the researchers write in their paper. In other words, because analysts have underestimated the CEOs who don’t belong to their in-group, those CEOs’ companies more often surprise the market when earnings are reported, boosting share prices.

“These results are also reflected in analysts’ buy and sell recommendations, with systematically more buy than sell recommendations for stocks of firms headed by CEOs belonging to their in-group,” says the paper, by Sima Jannati and Alok Kumar at the University of Miami School of Business Administration, Alexandra Niessen-Ruenzi at the University of Mannheim in Germany, and Justin Wolfers at the University of Michigan’s Gerald R. Ford School of Public Policy.

More here – The Wall Street Journal

WTF Is All The Fuss About

This article is apparently doing the rounds and it purports to look at the supposedly new development of predatory short selling and uses the attack on Quintix by the US group Galucus as proof of this and along the way we get the usual dose of perceived wisdom from Gerry Harvey. Whenever such a piece on short selling appears it is predicated on a few basic assumptions.

  1. Short sellers drive down the price of instruments thereby engaging in a form of pseudo market manipulation
  2. Short sellers tend to target decent businesses and decent people and are therefore un-Australian
  3. Short sellers know what they are doing and are always profitable.
  4. Knowing which stocks are being shorted will give you an edge.
  5. Predatory short selling is a new development.

The article identifies a series of stocks that are among the most shorted on the ASX and I have reproduced this list below since it gives me a starting point for looking at some of the actual data surrounding these stocks.


What I wanted to look at was some of the performance figures that you might derive from shorting these stocks. The first thing I did was assume that exactly one year ago 1 shorted $1 of each of these stocks. I then valued these stocks as of last nights close and generated the following table.

value of $1

The current value of this basket of stocks is $10.9, so in a year I have made $0.10, if I had simply bought the index and held it passively for the same period I would have made $0.11. Speculation has to be worth the effort, particularly speculation such as short selling that exposes you to substantial risks and can be regulatory and management nightmare. However, this sort of comparison is unfair since short selling is a trading strategy – it requires active management. So it would be more appropriate to look at the peak to trough movements in these stocks over the past year and this is what the table below tracks.


As can be seen some of these stocks have had substantial movements in the past year and there are only three where movement to the upside outpaces the move down. Interestingly, as a statistical fluke the average gain and average loss sits at 31%. From a trading perspective there always needs to be a recognition that stock prices move in both directions – unfortunately for passive investors fund managers only seem to accept that stocks prices move up. The value of short sellers is the knowledge that markets move in both directions and that this provides an opportunity for profit. However, this raises the additional question of whether short selling has both an influence on price and is utilized to make a profit. For this to occur large short selling positions need to be put in place whilst the stock is stagnant and then used to drive prices down. Therefore we should see an increase in the number of shorts before a stock falls and for this number to accelerate as pressure was brought to bear. To test this assumption I looked at some charts from the site which is used as the basis for the first graph in this piece and I have reproduced them below.


To be honest I am buggered if I can see a relationship between the lift on the number of short sellers and a decline in price. What I see is a mixed bag of short sellers being late, being early, not being there at all and getting lucky. Granted using the old Mark 1 eyeball is a dangerous thing and I cant extract the data to look at the true correlation between short sellers and price. But if it isn’t obvious then crunching it statistically to find some form of relationship isn’t reliable. So we come back to the basic questions I posed above and it is worth summarising an answer to each –

Short sellers drive down the price of instruments thereby engaging in a form of pseudo market manipulation

Not from what I can see. In fact if anything short selling is a boon to the market since it aids in liquidity, price discovery and as ASIC found much to its chagrin during the GFC it dampens volatility.

Short sellers tend to target decent businesses and decent people and are therefore un-Australian

People who complain about short selling fail to understand the basic mechanics of all trading is to elicit price discovery. The marekt then votes on its future view of this discovery – markets look forward not nackswards. So when you see the price of groups such as HVN get the wobbles it is the market voting about what it perceives to be the future prospects of this company in light of changes in technology, consumer bahvious and competition.

Short sellers know what they are doing and are always profitable.

Not from what I have seen

Knowing which stocks are being shorted will give you an edge.

See above – also consider the most you can make is 100% and that is functionally impossible. Simply Google best performing stocks of 2016 and this will give you an idea of the side of the market you want to be on.

Predatory short selling is a new development.

From my historical perspective I would say that short selling now is harder than it used to be. There are restrictions on naked short selling and the settlement system we operate under makes it hard to game the system. Back in the day when we had 14 day settlement you could short sell a company and buy it back before settlement and if you were careful no one was any the wiser. With instantaneous settlement this is actually very hard to get away with. As I said from a simple back office perspective short selling equities is a pain in the arse.





Jumping At Shadows

I was reviewing the latest Investment Trends data which can be viewed here. There are a few things that jumped out at me but I want to discuss the chart I have posted below.


This chart looks at the current fears investors/traders have about the market. What is interesting about these fears is that as you would expect they are all events that investors cannot control and they are also largely irrelevant. Whilst I understand that fear is a default setting for many particularly within the echo chamber of both social media and mainstream news the fear of an impending crash is an irrelevant one. My view that it is irrelevant is because in part this is a perennial fear for investors that never comes true. In many ways it is akin to having a fear of sharks when you go to the beach.


These two charts look at what might be termed the equity curve for investing $1.00 in the All Ordinaries Index in 1984 and the underwater equity curve of this investment. A few things are apparent – markets do have periods of collapse although not as often as you would think. The market went almost two decades without a pullback of 20% or more. Indices always recover – note I said the index not that market. Your stocks might be completely stuffed but the index recovers due to its upward bias.Survivor bias can work in your favour of you hold and index ETF.

The number of times that the index has ended with a week on week 20% decline are surprisingly rare as can be seen below.

ords zz

However, this style of data does little to assuage the nervousness of the irrational, even pointing out that simple systems exit the market in the initial stages of the market collapse offer little comfort. The conventional wisdom of the standard market participant is that they go to bed on Wednesday and wake up on Thursday and the market instantly collapses 30% on the open with no warning. This certainly was not my experience of the 1987 crash or the prelude to the GFC. In 1987 the market had actually peaked in September and the market became extremely unstable in the weeks before and had actually given up 10% and then gapped down before the crash. There was ample time and warning, the same is true of the GFC.

I perhaps shouldn’t be too hard on such market participants because the survey also notes that the majority of investors take their advice from market analysts.


Why Not To Listen To The Media And Brokers

A comment appeared in relating to this piece I wrote the other day and it deserves a fuller explanation. I will state at the outside that it is my contention that if you listen to the financial media and the sell side of the finance industry you will never get anywhere. And as a first step I recommend that everyone read Where Are The Customers Yachts by Fred Schwed. Now approaching its sixth decade it is still profoundly relevant.  In terms of broker advice as a source of recommendations upon which to build your wealth I thought I would look at an extreme example – Enron the US energy trading company that was in essence one giant scam. The trajectory of Enron’s share price can be seen in the chart below.

Enron chart

As befitting a company of Enron’s size it was covered by numerous brokers and you can see in the chart above I have highlighted the decline in Enron’s share price – this decline coincides as you would expect with it becoming known that Enron was a scam of massive proportion. The table below looks at the recommendations offered by brokers at this time. This table has a few components, on the left are the names of the brokers offering the recommendations, in the centre are the recommendations themselves. These are colour coded as to the type of recommendation and along the bottom is the price at which these recommendations were made. When viewing this table keep in mind the chart above.Enron

As you can see for the majority of the decline Enron was either a strong buy or a buy for the majority of brokers. Even after it became common knowledge that Enron was a fraud and was under investigation by the SEC brokers still continued to recommend it. In fact as it disappeared it was still considered to be a hold. So let me state that again – even after it was known that Enron was a giant con job and was headed down the toilet brokers still continued to recommend it. The most perceptive observation on this situation was actually offered by the humourist Dave Barry –

Wall Street relies on “stock analysts.” These are people who do research on companies and then, no matter what they find, even if the company has burned to the ground, enthusiastically recommend that investors buy the stock.

Dave Barry
February 3, 2002

This quite naturally raises the question as to why this sort of thing occurs and the answer can be found in the structure of the finance industry. In very broad terms  what people generally refer to as stockbroking has traditionally been split into two very broad camps – corporate advice and retail advice. Corporate advice covers high end activities such as capital raising, mergers, and company listings. Retail advice covers telling people who used to ring in to buy BHP because its a good company. Each of these arms generates a very different revenue stream for the firm, corporate advice generates fees in the millions whereas retail advice might involve an order that generates $6 in brokerage. You can see where the massive imbalance in revenue comes from and therefore you can see which side of the firm is more important. Consider a simple example, I head off to my local merchant bank/broker and I want to list my company to liberate some of the value in it and this listing will generate for the firm $5 million in fees. Naturally, if I want to list my company I need shareholders so it is the job of the retail arm to go a get them for me via selling the prospectus to them and after that via selling it to new punters via the secondary market. In terms of importance I am immensely important and my needs come first because I have given the firm $5 million, a retail investor doesn’t even give them enough for a slab of beer.

Underlying all of this is the simple need of stockbrokers to eat – stockbroking at its heart is a sales profession. If I dont sell you a second hand good in the form of a share then I dont eat. Even better if I can get you to sell one stock you own for another because then I get two lots of commission. You might think that with the advent of online trading that this situation might have evolved and changed because technology has removed the need to actually talk to someone. In some ways it has but it has also shown a new flaw in the advice model and that is in the recommendations that are generated by broking firms. If we think logically about markets then you would assume that markets are comprised of a mass of differing stocks, some doing well and going up, some doing poorly and going down and others doing nothing in particular. This is not how the industry sees markets – to them every single stock is a buy. Consider the table below which I generated a few years ago.


This chart looks at the ratio of buy to sell recommendations being offered by brokers. The lowest the ratio got was in 1983 when the industry were net sellers – this coincided with the beginning of the 1980’s bull market. Since then the industry has always been net buyers and the latest figures I could find indicate that the buy to sell ratio sits at around 100 to 1.  It doesn’t seem logical that for every stock that is a buy there could only be one that is a sell. The industry is overwhelmingly biased towards the buy side.

In looking into the industry over the years the best explanation for the behaviour of its members can be found in the following quote –

“An investor might expect advice that is free of both psychological bias and self interest. Instead they discover belatedly that the advice is a mixture of wishful thinking and self- serving hype.”

Brian Bruce Journal of Psychology and Financial Markets (2002 Vol 3, No4, 198-201)

As the question as to how to navigate all of this the answer is really quite simple – do your own thinking. If you want to be subject to the whims of others then that is fine but just remember this is an industry that had to be dragged kicking and screaming into acting in the best interests of their clients.




Index Correlations Again

I recently posted this table of index price correlations.

Index Correlations

Its a fairly simple table that  looks at the degree to which indices follow one another in their general pattern of movement. As you would expect indices that are closely related share a very high correlation. For example the Dow and the S&P500 share a price correlation of 0.97 which is almost perfect. The natural expectation would therefore be that the returns from these two indices would be the same – investing in one would be as good as investing in the other. However, when looking at price correlations things become a little more complicated. The chart below looks at the value of $1 invested in both the Dow and the S&P500 starting just before the GFC hit.

Dow vs S&P

As you can see there is a constant dislocation between the two. Price correlation and return correlation are not the same, in this instance the return correlation is a few points lower. To make matters more complicated all correlations are influenced by the time period you are looking at. The chart below looks at the value of $1 invested in the All Ordinaries and the Dow over the same time period.

Value of $1

There is a marked difference between the performance of the Dow and the All Ordinaries yet, according to our correlation table the correlation sits at a very high 0.74. What you think you see is not what you get – simply overlaying one price chart over the other would not have highlighted the significance of this difference. But this relationship is affected by the time period selected. The chart below starts much earlier and ends just before the GFC.

Value of $1 early

As you can see the situation is reversed with the local market belting the Dow.  It is obvious that over different times different markets will display different returns and that this difference is not a function of their price correlation. This presents a series of conundrums for investors in terms of which market to pick to invest in and it also causes problems for the notion of diversification. With regard to the problem of which market to pick this can be solved relatively easily by looking at the relative performance of markets on a regular basis. This is actually quite easy to do since both Yahoo Finance and Google Finance offer a comparison function in their very basic charts.

The notion of diversification is a harder nut to crack.  Diversification in the sell side of the industry is based around the idea that if things have different names then you are diversified. But this is a simplistic interpretation as you can see simply by looking at returns. It is possible for instruments to have different names but similar returns and if that return is negative then simply picking instruments on the basis of their name is flawed. To give you an insight into the issues that arise from looking too deeply at diversification consider the table below which looks at the differences in the price and returns correlation for the four major local banks.


As you can see the correlations are strong but quite different. If you were to pose the question as to whether the returns from all the local banks would be the same most would answer yes. Yet this answer would be wrong. In answering the question on diversification I have to admit a personal bias – I do not believe in traditional diversification for the reasons outlined above but also because I operate on a different philosophy. I only have a limited number of good ideas and if those good ideas share similar names then I will probably buy all of them. This as you would expect does introduce volatility into the returns as it sometimes goes wrong but it also sometimes goes right.

This does raise the issue of whether this is more of an academic interest rather than a practical one for traders. The issue of being in the right market at the right time is certainly a practical issue as local stock traders have largely been wasting their time since the GFC. The real gains in equities have been in the US as it has enjoyed one of the largest bull markets in its history whereas we have gone sideways with the occasional burst of short lived excitement. With regard to diversification I am ambivalent.

General Advice Warning

The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.