From: feste1599 2/10/2006 9:45:59 PM
of 17502
Reason for O/G stocks drop this week: hedge fund computer trading.
Check out this snip from professional trader Dan Noricini:
"The reason for this, in my opinion, is that we seem to have entered an era in which extremes in both price action and volatility can be attributed directly to the plethora of computerized trading platforms and system traders which are increasingly coming to dominate the markets.
Try to imagine if you can thousands of computers running technical analysis software which are tied directly to online trading platforms. These electronic trading systems are designed for speed and objectivity. In other words, they are designed to eliminate any guesswork and/or human factors when it comes to the actual execution of trades.
The way these things work is pretty straightforward. A hedge fund for example will purchase a system, whether for intraday use or longer time frames, which is programmed with a set of parameters that it tracks in order to generate buy or sell signals. These signals are all based on price movement of some sort. Some of the systems will trigger a buy signal for instance, if the price exceeds the high of the last 5 days or a sell signal if the price drops below the low of the previous 5 days. Others are keyed to moving average crossover patterns. Still others are yet keyed to oscillator crossovers. The point is that such systems can easily and quickly be set up to automatically scan price action in any given market that is desired to trade in for such signals.
Now comes the interesting part. These trading systems have the capability of interfacing with the trader’s electronic trading platform so that they can AUTOMATICALLY send the buy or sell signal directly to the exchange without the trader even having to manually enter the trade himself. The computer automates the entire process. The goal in employing such technology is to gain an advantage over the next guy by beating him to the punch and getting your order to the exchange first and as quickly as possible. The name of the game is speed and if you have to wait around for some carbon-based human life form to actually key in the order and send it, you have forfeited another 10 seconds or more – valuable time in which thousands if not tens of thousands of dollars can be lost due to execution lags as price begins to move leaving you a much poorer entry point.
Realistically speaking, this technology allows the hedge fund manager to be out on the golf course having a drink at the club house while his computer is sending orders to the exchange on behalf of his clients! Not that they are doing that (although the terrifying thought is that there probably are some that do!) but the potential is there. After all, once the system is set up properly, the entire system is fully automated.
At exchanges where the contracts are traded upon a fully electronic platform where orders can flow directly into the exchange’s order system, the result is a near instantaneous execution of an order that had a buy or sell signal generated only mere seconds earlier! You want to talk about lightning fast!
Think about this for a minute and you will begin to understand the repercussions of this development and how it can result in unprecedented barrages of orders flowing into the exchange at any given moment in time. In time past, orders had to be phoned in to a broker’s desk who then phoned it down to the floor which then sent the order into the pit via a runner to the floor broker who then executed it. The process had by today’s standard, a huge time lag. Not any more. The process is frighteningly efficient.
Now, I submit that it is this very process which lies behind the unbelievable wild swings and huge intraday price movements that mark so many of today’s markets, especially the futures markets. At any moment in time, thousands of these computers are tracking the very same price data in a given market. Any move that therefore triggers a sell signal on one will soon trigger a sell signal on another. That will trigger yet another sell signal on a third and so on and so on and so on.
In reality the sell signals are being triggered on more computers than one at a time but you can understand my point here. With all these fully automated trading systems sending their orders to the exchange within seconds of one another, all price movements become incredibly exaggerated as sell order upon sell order is piled upon the next. The net result is that existing bids can be swamped in a matter of mere seconds producing a snowball effect that quickly becomes an avalanche.
This is precisely what we witnessed in gold on Tuesday, February 8, 2006, this week. It is also the exact same thing which we have seen for better than a year in the copper market as well.
The interesting thing about this is that while the intraday sell offs can quickly cascade out of control, the price reactions seem to be finishing up much swifter than they have done in the past with the result that the primary trend is reasserting itself much sooner than was the case formerly. In other words, though the price reactions tend to be more brutal on an intraday basis, they also are completed in a shorter time frame before the market resumes the direction of the previous trend.
What I am advancing here is the notion that since so much of human judgment has been taken out of the picture due to this automation, there is little need for decisions by trading funds managers the following day or even the days after the price reaction. The computers take care of the whole kit’ n’ caboodle. Whereas formerly it took fund managers some time to evaluate a market and decide whether to sit tight or lighten up, that is no longer the case. The entire process has been taken out of their hands and given to a computerized platform to perform. It is done- caput, finished - objectively, swiftly and efficiently. So much so that I would venture to say that in many cases, hedge fund managers have been reduced to being mere spectators whose primary role is to pick the markets they want to trade in while leaving the actual buy and sell orders to the programmed trading system they are employing.
We then as a result get the swift, sharp downward corrections that we now have come to know only to witness the market within a matter of days go right back to trending as if nothing whatsoever had transpired. All the selling is taken care of at one time without any attention paid to subtlety or finesse. It simply gets done as the computer is not programmed to get its job done with skill – it is incapable of that – it only knows to sell and so that is what it does and it does that automatically by continuing to send its orders to the exchange until it has exhausted them. Unless that same system then somehow gets flipped to generating a new signal to go short, the selling is exhausted within a matter of days and there is no one left to further sell the market. At that point, fundamentally oriented traders looking to buy jump back in and the market then reverses itself and heads back up with the result that the same hedge fund computerized trading systems are now sending buy orders to the very market that they just finished selling a few sessions ago. Traders attempting to short these markets are literally blown out of them and forced to cover much to their stunned amazement. It is quite a strange sight to me personally to have observed this phenomenon which I first thought was a bit of an anomaly but am now coming around to believing is becoming the new norm for many of today’s markets. |
