Sunday, February 28, 2010

Reality? What's That??!!!!

Stocks Waft Higher, Oblivious to Reality
by Rick Ackerman on February 25, 2010
Stocks are in a warp now, moving in a parallel universe with no apparent connection to the observable world. The worst housing news in nearly 50 years pushed shares lower for a relative blink of an eye yesterday, then it was back to the races after Helicopter Ben affirmed for the umpteenth time that the Fed would not be tightening any time soon. Recall that it was just a week ago that the Fed announced it would raise the discount rate by half, to 0.75 percent. Even though this administered rate has become largely irrelevant to bank borrowing, the markets reacted as though the announcement had been momentous. The dollar soared, gold fell, and the unbiased observer might have concluded that something important had occurred. In fact, nothing of significance had changed. That’s because banks that face short-term stresses neeed not borrow directly from the Fed; instead, they borrow “excess reserves” from each other at the federal funds rate – the rate the Fed conspicuously left unchanged last week at 0.25 percent.

Wall Street has been assured of easy money for so long, and so many times, that one might have expected Bernanke’s latest re-assurance to have had no impact whatsoever. But the fact that it moved the markets higher does not necessarily mean traders thought there was anything new or significant in the Fed chairman’s speech. No, they bought stocks simply because they believed that’s what all the other traders would do. It therefore wasn’t the speech itself that caused stocks to rally, but rather the fear of being left in the dust when others reacted. And because there was no way to construe Bernanke’s message as bearish, the only option was to go with the flow and buy stocks.
Diabolical Machines
We use that word “flow” euphemistically, by the way, since shares are increasingly being driven up, down and sideways by computers imbued with diabolical cunning to do battle with each other. Do you remember the fearsome little creature that burst from the crew member’s chest in “Alien”? That critter was a good analog for the kind of primeval thought process it takes to succeed in the algorithmic trading world. The cutting edge these days is high-frequency trading, a good description of which was provided in the Rick’s Picks chat room yesterday by a trader who evidently knows what he’s up against: “This is done by the big boys, mostly banks that have high-speed computers co-located at the exchange (for the speediest nano-second execution) where they can read your orders in less than microseconds, take them from you and sell them to another bidder with the best spread before your broker can give you a read-back of your execution. They can read your stops, and when there are enough to justify a move, they will quickly buy up to them at millisecond speed in 100-share lots to spring your stops selling their accumulated inventory into them to make the fastest money you’ve ever seen. The SEC justifies all of this as ‘adding liquidity.’ Feeling ripped off yet?”
When it takes that much sophistication and cleverness for Goldman Sachs, J.P. Morgan and a few others to squeeze the last few billion dollars worth of “vig” from the world’s stock exchanges, the death of the game itself cannot be far off.

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