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“You’re Playing with Sharks”

Posted by Larry Doyle on July 22, 2010 6:20 AM |

Is it safe to go in the water? In other words, is it safe to play in the markets under the current construct? Do small retail investors truly stand a chance against the ‘big boys’ on Wall Street running high powered algorithmic trading programs and assorted other high frequency trading mechanisms? Are fundamental traders being thrown around amidst the ‘high waves’ and ‘strong surf’ pounding the shore?

No doubt, the scene on Wall Street has changed dramatically over the years. The onslaught of high frequency trading complete with a wide array of ‘bait and tackle’ such as flash orders, dark pools, naked access, co-location, and much more make it extremely challenging — if not downright daunting — for those who believe they can navigate these waters with simple ‘rod and reel.’

The Wall Street Journal recently highlighted the treacherous nature of the ‘water’ in the current markets in writing, Trend Investing Gains Its Share of Converts:

Volatile stock markets have left investor confidence in tatters. Now, some say it is time to accept the turmoil and adopt more-dynamic trading strategies.

Proponents of “trend” investing—buying and selling stocks depending on technical analysis of the market’s direction—say the tactic not only enables investors to navigate unstable markets, but also prevents big losses when prices fall.

This stance is winning converts at a time when concern about the strength of the U.S. economic recovery and the future of consumer spending is running high. Yet this technique is controversial, as it counters conventional wisdom that time in the market, not market timing, offers individual investors their best chance for success.

To trend followers, the notion of buy-and-hold investing—picking stocks based on fundamentals and keeping the investments for months or years—has no place in today’s market and, in fact, is a recipe for defeat.

“You have to understand the game you’re playing; you’re playing with sharks,” said Kenny Landgraf, president of Kenjol Capital Management in Austin, Texas . “You may believe in buy and hold, but there are large players out there that don’t.”

Navigating the current markets is not a leisurely activity for the ill-equipped or uninformed. While I am not an active day-trader, I am certainly respectful of the fact that the structure of our equity exchanges and equity markets overall have changed. The overwhelming percentage of equity volumes traded are directed by high frequency trading programs. In light of that, do not think for a second that the waters are not filled with lots of sharks. Navigate accordingly or otherwise, much like this scene from the 1975 summer thriller Jaws, you also may need a bigger boat.

  • phil trupp

    This is an excellent article. The markets haven’t merely changed, they’ve made a metamorphosis unrecognizable to many investors–and not just the retail trade; old hands are also at a loss in this brave new world of black boxes, high frequency trading, flash trades, dark pools, private placements, pump and dump, and off balance sheet transactions. The other day an ad on CNBC offered a black box programmed with various quasi-HFT algorithms for the at-home trader. Pick your very own algorithms and play like the pros: that was the thrust of the ad. Again, about “change”: many market watchers dismiss this euphemism and claim the that, in truth, the market is “broken,” and if not broken, it is fragmented by what appears to be a movement away from all matters of value and headed in the direction of so-called “trending.” Is it any wonder so many investors are turning away from the investing machinery that is now working against them? I remember when Jim Cramer called technical analysis “a substitute for homework.” He has since changed his tune and spends time trying to explain “head and shoulders” formations, “resistance” levels and so forth, the basics of technical analysis. Yet the black boxes resist even these efforts as high frequency trading gobbles up more than 70 percent of all daily trading activity. Could it be that the equity markets have become too clever by half? With investors turning away in droves, it would make sense reconsider the old basics upon which the market was built after 1934. Prior to that year, investors were not given prospectuses and pricing on any given day or week was virtually exclusive to the conflicted inside traders such as Joseph P. Kennedy who helped bring about the 1929 crash. We have gone from no information to far too much information. Worse, much of this information is gibberish; it is more useful to video game programmers than to investors who wish to participate in a value-oriented system guided by transparency. Is it possible that the markets are courting disaster? Could they be headed for irrelevancy? Are they driving away the very life blood of any market? Will we see a trend of large public companies going private? After all, today’s investing gimmicks are equal opportunity destroyers. Let investors invest and capitalism make a comeback.

    • LD

      Phil,

      Capitalism requires capital. With more and more investors out of the market and not inclined to come back anytime soon, capital is moving to where it feels protected. Wall Street is now paying the price for not protecting investors.

      Great comments. Thanks!!

    • fred

      Phil,

      Times change, we live in the age of technology. Most of the algorithms, etc. add “noise” in the short term but for the astute, this creates opportunity as securities can become mispriced.

      I do agree with alot of what your saying, but it’s not all wall street…where are the regulators that are supposed to ensure an “even playing field” for the little guy who can’t afford the large fees for access to the market makers book or doesn’t have access to an after hours trading platform in response to late earning releases or early morning gov’t report releases.

      I know it’s fashionable to bash wall street but I’m not so inclined to give corp executives a free ride, look at all the cash on their books, where are my dividends? why do they keep diluting my shares with massive stock options and buybacks?

      I’m not sure why you included trend investing as new age black magic, it has been with us for as long as the markets have been in existence and is probably more a reflection of underlying fundamantals both known and unknown than so called fundamental analysis ever was or will be. If you don’t believe me, go talk to Mr. Henry, the owner of the Red Sox. I’m sure he’d tell you that historically, trend investing has been much more reliable and profitable than making investment decisions based on fabricated and manipulated past and foreward earnings and PE ratios.

      With lower commissions, motivated by fear and greed, even the little guy is jumping in and out of the market trying to make a quick profit.

      Was buy and hold ever a valid investment strategy or just a fee generating scam promoted by brokers, ins cos, and mutual funds to seperate you from your money. If you believe so strongly in buy and hold, I have some AAA GSE’s due in 2020 I’d like to sell you at par, they’ve never lost a penny for anyone.

      • phil trupp

        Fred,
        You make good, thought-provoking points. I suppose I should admit I bought my first stock in 1956: AT&T and Merritt Chapman and Scott. The field of play was different back then. Over the years, I’ve moved with the markets and invested on the ever-changing underlying “fundamentals” and “technicals.” I’m aware that buy and hold no longer applies on a practical level; it has become a quaint memory of the past.I accept that technology has pretty much neutralized this once reassuring method of investing. My problem with today’s technology is that so much of it is unproven and unreliable. When I speak of “trend investing” I mean the practice of making bets on moving averages that have no fundamental support. I do a lot of technical analysis using S&P charts going back to the 1960s. Over the years, I’ve seen huge distortions that have no relation to a given company’s book value. Some traders believe that a good company can’t be shorted out of existence. In 2007-8 we had to question this assumption as the shorts tore the bottom out of many solid companies. Now comes HFT which, as far as I can determine, works on volume and tiny incremental price shifts, the purported value of which being that it creates liquidity. What I’m getting at is this: The market is becoming less about value and accurate pricing and more about whose algorithms stay ahead of the next tick. As for the “regulators,” I agree with you entirely. I didn’t want to get into politics because I have so little faith in the regulators. They have enabled a great deal of mischief and continue to do so. This, however, is a discussion for another time.

        • fred

          Phil,

          I’m sure you’ve done OK for yourself investing over the years and I think you’ll continue to do so. I think what your saying is that the fundamentally unexplainable volitility that exists at times in the market, scares the hell out of you and tests your resolve. I’ve done my share of swearing at the TV or computer screen over the years, the one thing I have learned is that I’ll probably never really know what the hell is going on so I practice active risk management and set conservative financial goals.

          • phil trupp

            Fred,

            You’re obviously a seasoned and sensible investor. I second your investing smarts. My fear is that a weakened market, broken in many ways, with trillions in cash on the sidelines, is not a healthy paradigm for growth on a macro scale. But this is a separate issue. We’re not going to grow as we should until tier one begins to flow. But the markets have spooked everyone; and the regulators, if not entirely clueless, are at best behind the curve. The market is a wonderful engine of potential progress. We could do with a little less gimmickry and more pro-growth philosophy.

  • Mike

    This broken market is all I know… anything before 2008 is ancient to me. It seems that real “investing” completely died out in 2000. The last 10 years have not been real growth, just a setup for our big collapse. There is strictly speculation now.

    Fundamentals? LOL. They’ll pick any BS reason to describe ‘why’ the market moved up or down on a day to day basis. Just stick to the charts and make your bets based on where you think the dumb money’s stop losses/margin calls have built up.

    • fred

      Mike, your right, we’ve gotten away from what made this country great, hard work and “gainful” employment. This has resulted in a reliance on financial engineering and “repackaging” rather than real growth.

      Gainful being defined in terms of true usefulness to society rather than an adjunct to the ever growing consumer spending component of GDP.

      • phil trupp

        Fred,

        Exactly.






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