[Long Post Warning] But I think worth it!
While we are on the topic of sell offs, I want to share with you and others here what I have come to understand about how NASDAQ stocks sell off. This "Anatomy of a NASDAQ stock sell off" is still incomplete and I would appreciate any input others here who have followed sell offs can offer me.
First off, I believe that NASDAQ MM can influence the activity on a stock and at times control the price action of a stock. One common motivation is the long inventory position that they maintain in a given stock. This is particularly true if the stock has been in a longer term uptrend. Another motivation is if the sell off is strong, they are long stock that they had to pick up at a higher price during the sell off. So they will use methods I have found to be common to recoup at least part of their losses. I have seen ample evidence of this over time,price action that cannot be possibly explained by the market forces of supply and demand.
There are basically two approaches MMs utilize in managing the trading activity on a stock that is being sold off. This type of sell off I am referring to that is significant is usually news related but this need not be the case. Once approach I will call the responsive technique, while the other I will call the initiative technique. Two stocks I will use to showcase each technique will be PHYC and IFMX. I will start with PHYC for this post and finish up with IFMX in another post.
PHYC sold off recently due to a recent earnings report. The revenue and earnings were up but the growth was lower this last quarter, and the forward statement made by the company indicated continued slower growth for the remaining part of the year. PHYC is made up of mostly speculators who always look for a good opportunity, on the long or short side, to make money. Much of the longer term players have already left the stock since the stock has been in a longer term downtrend. They has been a large and growing short interest in the stock. The net effect are traders who are very unforgiving with what the company reports and who are negatively biased toward the stock as in being willing to take the short side of a transaction. The sentiment is very low with this stock despite the fair earnings and revenue growth that has been reported in the past. Evidence is there that the players are looking for the stock to go lower yet.
Once the earnings report came out, the selling gapped the stock down the next morning past an important and well-established support. This is a sgins of things to come. As the selling progressed, the MM followed the selling down. This is a more responsive role by the MM to the sell off. The MM spent his time managing the changes in supply and demand with appropriate changes in the quote. After the stock went down a distance to an important level, the MM would take the quote and probe upwards. I think this was to check to see who was there to take the other side of this selling activity, to see if there has been any buying interest that is waiting to jump in. When this proved not to be the case, the MM would allow the price to be taken down further.
The trader's orientation during this sell off was to take the short side of the transactions. I saw basically two types of traders in this market: the trader who took their profit objective of lets say 1/4 of a point, and those that *anticipated* further price movement and would cover only when the stock a used for a period of time. As the selling continued, the trader became more greedy because the pause required for them to cover became significant. It is as though the market maker was helping them by saying "OK folks. Time to get off here!". The price may reverse at this point of continue further. In actuality I think it was the MM attempting to get people to cover by buying back the stock the MM now has it his possession, and then based on the results of this buyback, the MM would move allow the price move down to continue or take advantage of this pause in the selling to move the quote up to encourage others to cover their position. But this behavior on the part of the trader indicated to me there were allot of amateur traders in this stock which are in the position to get slaughtered on a reversal.
There were also traders who helped for a good part of the day waiting the sell off out. IMO this group was made up in part by the most intelligent players in this stock. Sell offs are just that: significant movement to the downside. By gauging the selling activity through the tape, this type of player can maximize their profits by covering at a later time. This becomes risky to do as the sell off continues, but if you know what your doing, it can be very profitable. I think the gap down was the clue here used by these traders. So when the sell off moved down the price a significant amount and the price arrived at a nice round number, some of these longer term day traders covered. They essentially behaved as position traders, except in the day time frame. Think about this for a moment. When a stock is rapidly moving down, do you think in terms of 1/16 and 1/8 of a point? Or do you begin to count the full points it has travelled down.? So it should be no surprise that the "value" oriented position trader would use this as a measure for when to cover. The smarter and more technically astute trader would hold and use this juncture to gauge the possibility of further selling and perhaps take part of their profits at this point in time.
The stock started in a running market right from its open. This together with the gap down gave strong clues that this would be a stock that will trend down for the day. During this selloff, any interim low made by the stock was retested and broken. Any move up by the stock was short in duration and quickly met resistance. At the resistance, sometimes 1/32 and 1/64 prints would show up, and the spread would shorten form 1/8 to 1/16. This is usually when the stock would reverse and continue its trend down. Very little number of position players came in value hunting. Some once again came in at whole numbers, but this type of buying activity quickly disappeared and did not show up again as the selling continued. This makes sense due to the profile of the stock that I have explained above.
Now an interesting thing happened that is characteristic of a sell off that is handled in this way by the MM. First, the stock started to make a bottom. This is where additional buying was encountered that was out of the norm given the trading action of this stock. Where I expected the stock to continue down, when it normally would, buying came in. These are either those "position" day traders covering their short positions locking in a nice profit, or very bold value oriented day traders who expected the stock to move up from here. The sizes on the trades indicated that it was likely the day speculator. But there was also some odd sized blocks greater than 1000 shares that may also involve value oriented position traders who trade for longer than a duration of a day. This IMO also would be a very bold move on their part since I think it would be more likely for them to wait for a bottom to form on their charts. The MM probed the other direction and encountered more selling which brought the price back down. The price of the stock moved a bit further beyond this last intraday low where it encountered more of this buying. This is when I knew a bottom is forming in this stock. This pattern repeated itself to end up at 8 1/4 from a sell off that started at about 10 where it opened.
The MM at this point in time took a more proactive role by quickly moving the quote up on the stock. I mean about one point in short order. The trading activity on the stock before this happened and that showed up while this happened did not support this price rise at all. You know those greedy shorts who waited for a long pause to cover? They were slaughtered. I know based on the prints that most did not have a chance to cover until 9. In terms that are used by bond salesmen, they had their faces "ripped off". Once the price rested at 9, there were some covering their short positions. You could even sense the anticipation of the rest who were hoping the price would move back down where they can minimize their losses. We are talking about real amateurs here. Then the flood gates opened and many traders started to cover their position. Then there was a lull. Here the MM is attempting to establish both a new trend and a new value area at 9 by holding the price at this level. Not an easy thing to do. Once a price level is established as a value area, then any move down made by the price is met with buying instead of selling anticipating the price to move down further. Then another large batch of buyers came in. I suspect these were the traders covering their short position that they made at the beginning of the sell off along with some truely late traders in covering their positions. Also as the buying continues and the price remained at 9, there were those ambitous traders expecting the price to continue upwards. This is the amateur taking a long trade in the stock. Perhaps they were attempting to recoup their losses. I do not know.
After a period of time wen by, the MM then started to move the quote up in response to the buying activity. He did not get far before selling came back into the picture. The MM then had to take the price down below 9 where the price of the stock closed. Even at the end of the day where the laggards would cover, it was not enough buying to move the price back to the value area of 9 that the MM was attempting to establish. So this tells me that the MM was not entirely successful but possibly has stemmed the selling of this stock. The next day of trading would tell.
The following day the MM opened the stock gapping it up. No surprise here. At this point, there was a "false" trend at the beginning of buyers entering the stock. This was in response to an upgrade by an analyst for this stock to a strong buy. During the initial hour, the stock established a trading range by moving back down and bouncing off whatI remember as near the open. Then selling came back into the stock. No surprise here given the previous day's closing price action. Also those who do not follow the stock intraday would be now know what happened and would looking to sell the stock. This took the stock down to 8 1/2 before encountering buying. This is a good sign. The previous day's bottom IMO was unconfirmed because the stock price did not come back to retest 8 1/4. I was expecting the stock price to retest this bottom which would be a good thing. Instead, buying came in at 8 1/2 demonstrating confidence on the buyer's part that was not there the day before. However, the stock closed near the low of its trading range for that day indicating more selling is to come which may retest the 8 1/4 low the stock made the previous day. The position players who do not closely follow the stock will read their newspaper over the weekend to find out what had happened and respond by selling this coming Monday.
Bob Graham |
