DynamicHedge recently posted an opinion piece that caught my eye, Hand Crafted Short Squeeze Reversal
The point of the story is in the final paragraph, but this is an interesting read.
Program trading is real and a big part of the daily moves we see in the broad indexes. What we saw recently was a series of targeted buy programs move the market and sentiment in a big way.
We opened the day with a small gap down and a decidedly negative tone. All the news flow crossing my desk was ruthless. We should have been down 20-30 handles [MDW: SPX points]. But things were slow and going into lunch the market didn’t break lower by any significant amount. We can thank POMO [MDW: The Federal Reserve is believed to have a Permanent Open Market Operations to pump cash into the market] or whatever for providing a perma-bid in the market, or we can fall back on the old adage, “Never short a dull market.” Who really cares why the market didn’t break — the simple fact is that it didn’t.
No new lows into lunch means that we’ve gotta go somewhere and that somewhere is probably up.
The first buy program rolled through the thin lunch-time market catching everyone off guard. On a thin tape, even a small buy program can move the S&P Futures multiple handles. This buy program moved the S&P to the previous days cash close and lifted the short-term scalping indicators such as the widely followed NYSE Cumulative TICK to extreme readings. There are short-term traders who fade these temporary conditions. The fact that they occurred in conjunction with S&P hitting the previous close and filling the gap (resistance area) made it look like a particularly high probability setup at the time. This is a classic bear trap to bank some built-in demand.
After the bear trap was set the second buy program rolled through to blow out the faders who took the short. They are weak hands and will bail on the trade at a moments notice. The buy program traders know this and push the market up to activate buy stops. Hence the built-in demand.
The third buy program was the smallest of the three. Just a peppering of buy orders to clean out the remaining buy stops. There’s no size sellers left for the day at this point. The late longs and stubborn shorts are coming in to buy and the program traders sell to them to flatten up most of their position for the day.
At this point in the day the trading world has gone from focusing on the lows to focusing on the highs. All that remains of the bearish thesis is a few news stories and a bunch of frustration. Back to the grind.
For those out there who wanna cry foul, I’ve got news for you: program trading is not market manipulation or anything immoral or illegal. Remember, this is the game you signed up for. These guys have way more money than you and are MUCH better traders than you. Do not whine about how it is somehow unfair or the game is rigged. Of course the game is rigged.
Whether the market is always rigged, or whether rapid program trading is felt occasionally, this is not your father’s stock market. The game has changed over the years and you are playing against computers. Just as chess and Jeopardy champions were defeated by computers, it’s inevitable that computerized trading will eventually suck so much cash profits out of the stock markets that few human players will remain.
I can understand why technical analysts believe in their numbers and charts. Even when they don’t produce a winning trade entry, they serve a purpose by getting the traders out of dangerous situations before losses mount. On the other hand, fundamental traders or investors may take a stance and stubbornly refuse to exit a bad trade. That the path to financial ruin.
You may not like it, but “the markets can remain irrational longer than you can remain solvent” [John Maynard Keynes].