For some time now, I've mentioned that high frequency and algorithmic trading are two of the reasons why it has become much more difficult to trade the major markets. Their speed and deep pockets have real impacts on price action, both within the trading day as well as over longer term periods. And while I am all for the development of new trading technologies that enable additional profits to be made, it seems to me that these systems are being given advantages that the vast majority of investors (not just those on the retail side) are not provided. Among the most egregious of these advantages is the widely talked about 'co-location' of algorithmic traders' servers next to the various exchanges. By obtaining this close proximity, these traders are able to execute orders at a rate that no one else can match and, thereby, ensure they are the first to take advantage any price dislocations that occur. In my mind, this is tantamount to front-running orders since these dislocations are not able to been seen outside of these systems. Supporters will claim that these systems provide additional liquidity to the markets which makes trade execution more immediate and efficient. To an extent they are correct, but, as usual, they miss the larger point: this is a practice that virtually no other investor is able to take advantage of. Keep the playing field level, or as level as it possibly can be.
So why the rant about HFT? Aside from the issues I obviously have with the practice, I highlight them as a reality that we all must face as investors. We can complain and debate the virtues and vices of HFT, but until the practice is banned we've got to adapt. And with that in mind, I believe that this week's price action is a good example of why evaluating the markets in a purely fundamental or technical manner is perilous. In particular, Monday's move above the 1,131 level on the S&P 500 appears to have been a calculated move by various trading houses to shake the numerous short positions and stop-loss orders from the market. Among these, no doubt, were a large number of program traders. This action had the effect of moving prices sharply higher in a relatively short time frame with virtually no fundamental data driving the move. As a result, many technically-based momentum traders were tempted to chase the market higher due to the apparent breakout above 1,131. But as I wrote at the time, the lack of news underlying the move along with a lack of a sustained close above 1,131 (and above the 200-day exponential moving average on the weekly chart) was a reason for remaining cautious until confirmation materialized. And as today's 0.83% decline in the S&P 500 shows, this caution was warranted. In fact, with today's close, the S&Ps are now back below the 1,131 level. Considering the light volumes that have been in place, the breakout/breakdown feels very much like an engineered move designed to generate some fast profits.
This is the reality we face. Is it frustrating? Yes. Is it fair? Probably not. But once we accept the fact that this is the paradigm in which we must operate, you realize that these games can be taken advantage of if we look for price movements that simply don't make sense. That's what Monday's move looked like to me. And with the market initially rallying after the Fed's release on Tuesday and then reversing to finish lower, this was the sign I needed to confirm that the bullish sentiment that had moved the market higher had been hollow. With that signal, I was given the confidence I needed to place a short position on the equity market at a price above the 1,131 level. Had this gamesmanship in the marketplace not materialized, any short position I initiated would have been at a lower price level with a commensurately lowered profit potential. So while the program traders are able to make a little extra money through their sheer weight, I can at least benefit somewhat from their heft if I'm willing to remain diligent and keen these strange price movements.
Today's lower move in the equity markets, while certainly driven in part by the technical factors I've mentioned above, was aided by the negative initial jobless claims data that was published this morning before the bell. Consensus expected a reading of 450,000 claims during the previous week, but the actual numbers proved more negative at 465,000. As with so many of the economic data points that have been released over the past year, their directional movements have been vacillating around an absolute level that is well below the levels seen prior to the economic downturn. Jobless claims data has been no different. By and large, these readings have been sitting around the 450,000 level, which clearly shows that the domestic economy is still mired in a negative state, so getting too bullish or bearish as a result of the recent releases is perilous. More than anything, the market's willingness to interpret the data as negative 'news' says more about a shift in sentiments to the negative side of the ledger than any economic insight that was gained. This sentiment shift was again confirmed by continued strength in gold as well as a resilient Treasury market.
Looking to tomorrow, I'm looking for another down day. Looking at the historical performance of September 24th, the day's expected performance is skewed markedly to the downside. A decent durable goods or new homes sales report could keep a floor under the market, but my sense is that the numbers would have to be extremely positive to move the market meaningfully higher. This doesn't seem likely in my opinion. Until tomorrow.....
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