One thing is clear: These aren’t your daddy’s markets anymore.
Why? Because about 10 years ago the Rise of the Machines (aka high frequency trading algorithms) completely altered the terrain of what we call the ‘capital markets.’
Let’s look at this as a before and after story.
Before the machines, markets were a place that humans with roughly equal information and reflexes set the prices of financial assets by buying and selling. Fundamentals mattered.
After the machines took over, markets became dominated — in terms of volume, liquidity and pricing — by machines that operate in time frames of a millionth of a second. The machines and their algorithms use remorseless routines and trickery — quote stuffing, spoofing, price manipulations — to ‘get their way.’
Fundamentals no longer matter; only endless central bank-supplied liquidity does. Because such machines and their coders are very expensive and require a lot of funding.
The various financial markets are so distorted that I first resorted to putting that word in quotes – “markets” – to signify that they are not at all the same as in the past. In recent years I’ve taken to putting double quote marks – “”markets”” – in attempt to drive home their gross distortion. Not only are todays “”markets”” something the human traders of a generation ago would fail to recognize, they’re no longer a place where human actions of any sort have much of a remaining role.
Why care about this? Two big reasons:
- Such “”markets”” are easily manipulated by central banks and other state actors by virtue of their automated responses to liquidity injections. Are the markets going down when you don’t want them to? Just use any one of several highly leveraged means of signaling to the computers that it’s time to buy instead of sell. Common leverage points include the Japanese Yen-to-USD price level, selling VIX to lower volatility, and buying massive quantities of index futures ‘all at once.’
- These manipulations will work until they don’t. When they fail, they may well fail spectacularly — resulting in shattered markets that have to be shuttered until the damage can be assessed. Investors will not be able to access their capital, either to buy or sell, while things get sorted out. When the markets finally do reopen, valuations will be a whole lot lower due to the loss of the huge block of (phantom) volume previously supplied by the now-shut down algos.
The main predicament were facing is that by jamming the “”markets”” ever higher, the central banks have created an enormous gap between current prices and reality.
An easy to see example of this is the housing market in San Francisco, where average income earners cannot afford average houses — at all. The only way the SF housing market can re-balance to a sustainable level is either for salaries to shoot up massively (while house prices remain flat) or for house prices to fall.
Equities are no different; their prices current suffer from a similar “reality gap”. The same is true for bonds.
Obvious Price Manipulations
Just to show that I’m an equal opportunity critic and don’t just think gold and silver are manipulated — and they have been and continue to be, which is now a matter of fact — I warn that the same dynamics that infest the precious metals “”markets”” at the COMEX indeed happen elsewhere.
My conclusion is that the HFT computer algos are in complete control of the “”market” action, and play with and off of each other to create massive sudden price movements that have nothing to do with anything except book order saturation.
Today’s recent example comes to us courtesy of the WTIC oil market on the NYMEX:
Starting around 6:30am, oil futures started drifting slightly lower. A little volume came in around 6:40 a.m. and then — BAM! — right at 6:44 a.m. EST, a super spike of volume to the downside occurred. I happened to be watching this in real time and began counting off seconds. Before I got to 3 seconds it was over. (These are one minute bars so those three seconds are obscured in a full sixty second long bar).
So…8 thousand contracts in 3 seconds. Staggering.
For fun, amortize this out over a full trading year. It’s a preposterous figure.
The point being, these volume spikes (especially to the downside) have an intensity that is simply overwhelming for the market structure.
Which is entirely the point of the operation. That’s the very essence of price manipulation.
Let’s try to look at this rationally. Let’s define intensity as “volume of more than 2 standard deviations above the recent 1-hour average, divided by the duration of the volume event.”
If we do this, an analysis of the oil chart above would go like this:
Say the average volume was 200 contracts/min. The normal ‘intensity value’ would be 0, because there are no moments above 2 std before the big volume spike (0/0)
Making a guess of a std of 300 for the normal period, at the height of the spike, the value would be ~7,400. Then divide the 3 second episode (expressed in minutes) and you get 148,000.
So from an intensity value of 0, thing spiked up to 148,000 in a matter of seconds.
Is that a useful number or way to look at this? I think so, because it expresses the idea that these volume spikes, combined with their extremely short duration, have an intensity that is far outside of the normal trading bounds. And it’s that super out-of-range characteristic that just clobbers the price of whatever is being traded (in this case oil, one of the most widely-traded commodities on the planet).
These blasts destroy the market bid/ask structure in those moments. You have literally zero chance of trading that event as a human, even and especially if using ‘insurance’ like stops.
This means that the “”markets”” have a barrier to entry where the cost is the price of a very expensive arrangement of hardware and software capable of operating at the micro-second level. Humans need not apply.
These are not your daddy’s markets. They belong to the big players (aka big banks and hedge funds) and their very expensive machines.
Understanding Volume vs. Liquidity
What we’re really describing here is a sudden spike in volume that basically destroys the current market book of orders.
What that means is this. Imagine that you are selling eggs at the farmers market along with nine other vendors. There are 500 people wandering the market looking for eggs and other produce. The average sales rate for all 10 egg vendors and all 500 customers is 5 dozen eggs per minute.
The price you can sell your eggs for is set in accordance with the other prices around you. Yours are organic, but small. The vendor next to you has large eggs that are conventional, but larger. And third has small colored eggs from heritage breeds that are free range. Let’s say that the range of selling prices is from $4/doz to $5.50 per dozen. This is the market structure for eggs at our