Here’s the lawsuit’s background. In the summer of 2007, Sentinel Management Group was an investment manager that marketed itself to its customers as providing a “safe place” to put their excess capital, offering them short-term returns with ready access to their cash. Most of Sentinel’s customers were Futures Commission Merchants (FCM’s). Sentinel assured their customers that all customers’ money would be held in segregated accounts, as required by law. In their advertisement they stated that “Sentinel has constructed a fail-safe system that virtually eliminates risk from short term investing”. But instead of maintaining its legal obligations, Sentinel pledged hundreds of millions of customer assets to secure their overnight debts, leaving their customers without their funds. Subsequently Sentinel filed for bankruptcy.

Sentinel maintained three types of accounts. They had clearing accounts allowing them to purchase securities (government, corporate and foreign). The bank maintained the right to place a lien on the assets in clearing accounts. Sentinel maintained an overnight loan account with a secured line of credit. And Sentinel maintained segregated accounts that held assets that could not be subject to any bank lien.
Sentinel was required to countersign letters acknowledging that the funds belonged to the customers and that the accounts were not “subject to lien or offset for, and on account of, any indebtedness now or hereafter.” Moreover, Sentinel’s agreement stated that they would have no claim or lien against securities held in a segregated account nor will they grant any third party any interest in these securities.
However, Sentinel began to use segregated account funds to meet their demands for collateral. First $88 million, then another $66 million, until the segregation deficiency had grown to hundreds of millions. When Sentinel filed for bankruptcy, Frederick Grede was appointed Chapter 11 Trustee. He filed a $312 million claim stating that Sentinel had fraudulently used customer assets to finance their loans to cover their trading activity.

In hearing the arguments in a trial that lasted 17 days, the court ruled in favor of Sentinel finding that Grede “failed to prove that Sentinel made the Transfers with the actual intent to hinder, delay or defraud its creditors.” The court ruled that Sentinel’s conduct was not “egregious or conscience shocking” but was at worst negligent. Grede maintained that Transfers violated federal law requiring Sentinel to maintain segregation, and that transferring funds from segregated accounts to lienable accounts to repay Sentinel’s repos, was “actual intent to hinder, delay, and defraud its customers”.

The court found that Sentinel used the funds with the “genuine belief” that they could repay their debts if they could “weather a financial storm”, and did not constitute fraud. While the court found that such an arrangement questions sound financial policy and good business practice, that alone does not mean Sentinel intended to hinder, delay or defraud its customers.

This decision now puts brokerage accounts at risk for all customers. Requiring customers to establish “intent to defraud” should their segregated funds be used as collateral for brokerage debt is nearly impossible. Even the National Futures Association (NFA) has increased protection for futures customers, given the $200 million hole in funds from Peregrine Financial Group (PFGBest) and the $1.6 billion shortfall from MF Global. The new NFA rules require brokerages to provide regulators with internet access to customer’s segregated fund account information. How then can the District Court demand that customers establish “intent to defraud” when their segregated funds are taken? Does the court understand the implications of their decision? U.S. Money market funds currently hold roughly $2.7 trillion dollars in assets. These accounts are now at risk because of this decision. Whenever a brokerage decides to use segregated funds, the customer must establish that the brokerage had an “intent to defraud.”

In 2007, major U.S. brokerages had defrauded their customers $330 billion dollars by telling them that they were storing their funds in “tax-free money markets.” In fact, these accounts were auction rate securities, whose auctions had failed and the money was frozen. Per the decision of this court, no customer would have been able to reclaim their funds because they could not establish “intent to defraud”. The court would have said, “questionable business decisions” but not fraud. Therefore the thousands of customers who lost money would not have been allowed to claim anything. Moreover, the millions in funds lost to customers by PFGBest and MFGlobal would also not be claimable. Why should Sentinel’s customers be required to claim “intent to defraud?” Removing funds from segregated accounts is illegal. There is no need to claim “intent to defraud.” In brokerage agreements, including Sentinel’s, it is written clearly that segregated accounts cannot be used as collateral. Why then would the court require Sentinel’s customers to establish intent to defraud?

Because of the court’s decision, all brokerage customers should be afraid. Now they know, brokerage agreements aren’t binding. Brokerages have no legal requirements to uphold their own documents. People who have their funds in Money Market accounts should withdraw their funds, since the agreements don’t bind the brokerages…brokerages suddenly are above the law.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

High frequency trading robots (HFT’s) now account for 73% of the daily volume. In 2007, automation accounted for just 30%. In four years, HFT’s have more than doubled their trading activity. Their ability to succeed strictly depends on speed, how quickly they can enter and exit orders. The need for speed has caused corporate office buildings in New York and Chicago to be emptied, only to be replaced by large computer servers. Submarine fiber optic cables are being set down from New York to London in order to shave .006 seconds off trade execution.

The question under debate: “Is high frequency, robotic automation good for Markets in general”? High frequency trading firms would argue, categorically, “yes”. HFT’s claim that they bring liquidity to the Market (how quickly investors can buy or sell an asset, converting the asset back to cash.) Currently, there are 20,000 trading firms in the USA, yet only 2,000 are high frequency. Given that HFT’s now account for 73% of the Market’s “liquidity”, the majority of Market activity then occurs between transactions from these firms, buying and selling the same shares, back and forth to each other, for a fraction of a cent profit on every share traded.

While HFT’s may argue that they bring liquidity to the Market, they cannot dispell the allegations that liquidity comes at a very high price to investors — volatility. In a report issed in September 2011, associate professor Frank Zhang of Yale University stated that once an instrument’s share volume exceeds 50%, trading becomes basically a “hot potato,” as HFT’s trade the same positions, passing them back and forth amongst themselves. Inter-firm trading all but eliminates “Price Discovery”, determining share price by normal supply and demand factors, such as news events or positive/negative earnings releases.

Inter-firm high frequency trading also wreaks havoc for Mainstreet investors because of “cross spreading”. So many liquid stocks, such as BAC and MSFT, now execute in milliseconds, resulting in extreme “competition” for Mainstreet investors. Queues to enter and exit are significantly longer, with hundreds of shares waiting to execute. Long queues force Mainstreet investors into the vulnerable position of having to buy at the offer or sell at the bid, a trading method known as “crossing the spread”. Under normal conditions, investors would buy a limit order at the bid and let the Market cross. But with extreme competition from millisecond trading, the only way to “get filled” is to cross, thereby increasing trading costs / reducing profits

With HFT’s orchestrating 73% of the trading volume, is it any wonder that stocks experience “air pockets”? With high frequency trading hindering the Market’s ability to convert corporate fundamentals into share prices, HFT’s are literally creating their own stock prices, arbitrarily raising shares higher, only to drop them back down in milliseconds. Air Pocket trading is not a “once in a lifetime, Flash crash of 2010″ experience any longer. Since 2007 there have been 18,520 such instances of flash crases amongst highly volatile stocks, roughly 10/day. These small crashes have now become the operating normal as HFT’s control the Markets, trading the same shares back and forth, looking for the same opportunities, their algorithms pretty much the same as well.
Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

What was the computer glitch that Knight Capital faced? Their algorithmic trading software sent erroneous orders to NYSE-listed securities, rapidly buying literally millions of shares in more than one hundred stocks, pushing the value of those stocks higher. The company was then forced to sell the higher-valued shares back to the market at the lower price, causing the extreme loss.

What is algorithmic trading? Algorithmic trading, otherwise known as robotic trading, or trading from a black-box, is the use of computerized decision making for initiating trades to the exchanges. The software, itself, decides on the security price, liquidity available, timing (how quickly the order can be filled), overall risks and costs associated with the trade. Computerized decision making, in the vast majority of cases, is done without human intervention.

Let’s put algorithmic trading into perspective to understand just how Knight Capital could lose $440 million in 45 minutes.

• 1 second is 1,000 milliseconds
• 1 millisecond is 1 million nanoseconds
• One blink of an eye takes 300 milliseconds
• The default for one mouse click is 500 milliseconds
• The average human reaction time is roughly 250 milliseconds
• For a professional chess player to decide on the next move is 650 milliseconds
• From the moment that a ball leaves his opponents racket until it hits his own, a pro tennis player needs 500 milliseconds

In the time it takes to blink an eye, click a mouse, make a decision, or react, computerized decision making algorithms have received the datafeed from the exchange, analyzed it using various technical indicators, initiated their orders and been filled. If it takes less than 1 second to initiate trades and be filled, there is no possible way human oversight can stop “computer glitches.”

Exchanges have no one to blame but themselves. There are approximately 20,000 trading firms operating throughout the various exchanges today. Algorithmic trading firms comprise just 2% of all the firms. Yet these 2% represent 73% of the total daily U.S. trades. In a PBS documentary on March 15, 2012, Paul Solman reported that across the exchanges (NYSE, NASDAQ, AMEX, CME, NYMEX), the average trade time is now 22 seconds. A $300 million transatlantic cable is currently being constructed between New York City and London just to shave off 0.006 seconds. Physicists are now working on execution times at the speed of light, down to picoseconds (1 trillionth of a second).

Remember the Flash crash of May 6th, 2010 where a $4.1 billion automated sale triggered thousands of sells throughout the Markets. From that crash a study was conducted, led by Neil Johnson, a complex systems specialist at the University of Miami, and simulation engineer Brian Tivnan of the University of Vermont. They analyzed millisecond-scale price logs from 600 markets, using numbers gathered by Nanex live market data. What they discovered was that from 2006 to 2011, there have been roughly 18,520 sub-950-millisecond crahses and spikes, about 10/day. The Flash crash of May 6th was just waiting to happen.

Human decision making takes into account diverse aspects of the Market’s behavior, both technical indicators as well as fundamental interactions (overall market performance, whether it is an up or down day, emotional reactions due to news releases, etc.). What Tivnan noted was that algorithmic trading tends to “sacrifice diversity for speed”. He said, ” You see a lot more homogeneity at the sub-second scale than we see above 1,500 ms.” So many algorithms are likely to concentrate on a small set of strategies, having optimized for speed, resulting in algorithmic trading becoming vulnerable to systemwide “herd mentality”.

Is it any wonder then that a computer glitch could take just 45 minutes and cost a company $440 million?

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

Price has been said to be the best indicator of Market direction. Traders identify price action patterns (price oscillation swings from low to high and vice versa) through technical analysis, such as double tops and bottoms, moving average crosses, MACD, overbought, oversold, support and resistance. For traders, price action patterns imply future Market direction. Traders rely on pattern recognition in an effort to succeed. Technical indicators are used as potential stop loss or target levels. Price action is an effective trading system.

But was it price action this week that caused the Market to swing higher by 400 points? Or was it just Market Sentiment?

What is Market Sentiment? Market Sentiment is the predominant attitude amongst institutional traders, such as hedge funds, mutual funds, etc. Institutional traders are directly influenced by economic events, assumptions, overall behavior, even gut feelings. Sentiment measures Market optimism or pessimism. Optimistic market sentiment shows market participants willing to add to their existing holdings and acquire new positions. Pessimistic market sentiment demonstrates that market participants are unwilling to add new positions and are liquidating existing holdings.

This last week was driven strictly by Optimistic Market sentiment. Technical analysis did not warrant a 400 point increase in the Dow. How did market sentiment turn optimistic? Simple…the ECB spread rumors that it would purchase Spanish debt. There was no official German denial. Merkel was on vacation. Germany’s Finance Minister, Wolfgang Schauble made no statement one way or the other.

This was followed up by comments made by European Central Bank President Mario Draghi. On Thursday, Draghi promised “to do whatever it takes to save the European single currency.” He basically stated that he would lower the high borrowing costs for Spain and Italy. Draghi told London business leaders that the ECB would “do whatever it takes to preserve the euro” and then said, “believe me, it will be enough.” This left Market sentiment extremely optimistic going into the weekend.
But wait. Is Market sentiment about to change? And will price action once again drive the Market? Over the weekend, Finance minister Wolfgang Schauble finally spoke. He stated in Spiegel that “For days, it is rumored that the ECB will buy Spanish government bonds in a big way, he said, “No, this speculation is not true.” Schauble said that the 100 billion euro package to recapitalize Spanish banks along with an emergency aid of 30 billion was enough. “The short-term financial requiments of Spain is not so great”, he said. “The high interest rates are painful, and they create a lot of anxiety — but the world does not go under if you have to pay for some bond auctions a few percent more.”

Schauble’s comments may undermine the optimistic Market sentiment statements from Draghi this week. And here’s what we all want to know: were Draghi’s comments nothing but hot air, bluff, or down right lies? The Market had dropped 300 points in 3 days. Market participants were looking for any reason to run the Dow and S&P back up. Draghi’s comments could not have come at a more opportune moment. But was it all a fake, just to stop the Market from falling even further? If Market sentiment drops out this week, price action will again take control of the Markets, with technical analysis driving the price lower. Watch the Euro’s price on Sunday night / Monday during the European day session. If last weeks comments were nothing more than hot air, the Euro may be headed back down towards 1.20.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

Look at what’s happened over the last 9 months. Nine months ago, MF Global used approximately $700 million in customer segregated funds to meet its liquidity issues. In total, $1.2 billion went missing. The $700 million was supposed to be “segregated.”

When a futures trading account is opened by a customer, a check is written or funds wired to a registered FCM regulated by the CFTC. The funds are deposited in a customer segregated account at a major bank, such as Harris Bank in Chicago. Segregated accounts ensure that, even if the FCM were to run into liquidity issues, that would have no impact on the customer’s individual account. By law, FCMs may not commingle their business funds with the funds of their customers. The only case in which funds may be removed from customer accounts is when the money is being taken to cover the customer’s own liabilities. It is the CFTC’s responsibility to monitor FCMs, ensuring that FCM business funds are never commingled with segregated customer funds.

MF Global did run into liquidity issues. They made high risk investments in European Sovereign debt that were not profitable, accelerating their liquidity shortfall, ultimately resulting in their own bankruptcy. In an attempt to handle their shortfall, customer funds were, in fact, commingled, and lost. But here’s the real problem. The CFTC is expected to conduct regular audits, ensuring FCMs comply with rules and regulations regarding commingling. How then did MF Global manage to commingle $700 million of customer funds if the CFTC was doing its job?

Fast forward 9 months. FCM Peregrine Financial Group Inc., PFGBest, commingles and loses $215 million of customers segregated funds. Regulators actually revealed this week that PFGBest had been “deceiving” the CFTC for more than 2 years. How was loss discovered? The CFTC finally verified customer assets electronically instead of relying on paper statements. Unbelievably…the CFTC never actually ensured that PFGBest segregated funds for 2 years. That’s right, count them…2 years. What makes this even worse is that PFGBest had already been the subject of enforcement actions many times, including February of this year.

In an article published in ZeroHedge, Tyler Durden revealed that PFBBest, on a level of 100 to 0, was ranked just 41, 4th from the bottom of all FCMs. What was the most obvious problem noted is that other futures brokerages similar to PFGBest had one or two CFTC/NFA Disciplinary Actions. PFGBest had 76. 76 disciplinary actions and the CFTC relied on years of paper statements instead of verifying segregated accounts electronically. Now take a look at the “new rulings” from the CFTC. Remember…these are “New Rulings.”

“FCMs must hold sufficient funds in secured accounts to meet their total obligations to customers trading on foreign markets computed under the net liquidating equity method representing the total account balance owed to customers.”

“FCMs must maintain written policies and procedures governing the maintenance of excess (i.e., proprietary or residual) funds in customer segregated accounts.”

“Any withdrawals that are in excess of 25 percent of the excess segregated secured funds that are not for the benefit of customers must be pre-approved in writing by senior management and FCMs must file notice with NFA of any withdrawal of 25 percent or more of the excess segregated funds that are not for the benefit of customers.”

“FCMs must file on a daily basis with the NFA segregation. FCMs must file with the NFA detailed information regarding the depositories holding customer funds and the investments made with customer funds as of the 15th and last business day of each month; and FCMs must file with the NFA additional monthly net capital and leverage information.”

It took a billion dollar loss for the CFTC to finally “enact rules” requiring FCM’s to report. But looking at the “new rules”, are they really new? The CFTC requires written policies and procedures. Shouldn’t those already be in place for years? Pre-approval of segregated fund withdrawals. Shouldn’t this also be an existing rule? So what actual changes did the CFTC make on Friday the 13th that weren’t already in place? What did they rule that will ensure that 9 months from now, another futures brokerage won’t be commingling their funds and stealing customers segregated accounts.

So often FCMs testify in front of Congress that they need less banking regulation. They don’t want the Dodd/Frank bill implemented and lobby heavily, stopping the CFTC from activating the laws that were passed. Imagine what trading would be like in a completely unregulated world, driven by Wall Street greed. Talk about buyer beware. Markets in America have a reputation of having oversight, ensuring a level playing field for all. MF Global, PFGBest, and the CFTC’s lack of monitoring give a whole new meaning to “level playing field.”

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

Despite the run of the Market throughout June and now July, what makes no sense is why U.S. Treasury Bonds and Notes continue to fly higher? Traditionally, stocks and bonds/notes have what is known as “negative correlation.” Negative correlation refers to a relationship between two Markets in which one Market increase directly proportional to the other decreasing. In the case of stocks and bonds/notes, when the Stock Market rises, bonds/notes fall, and vice versa. When the Stock Market rises, investors feel that their return on investment is much better by purchasing stocks and securing dividends. But when the Stock Market falls, investors flee to bonds or notes as a flight to safety.

What is just not easy to explain this week: why did bonds/notes not retreat? All the while the Stock Market was flying up, the bonds and notes alike stayed flat. They did not rise, but they did NOT fall as expected. In fact, by Friday, the 10-year Note had exceeded 134. So what does this show you? Why are investors flocking to treasury bonds and notes when the Market is making a strong recovery? What makes this especially confusing is that right now the yield on the 10-year note is just 1.54. Again, why would anyone run to buy Treasury Notes with almost no yield?

What also makes this preference so unusual is that the U.S. economy is not displaying a significant recovery. The unemployment number, 8.2%, did not improve from last month. In fact, the actual new jobs made was only 84,000. April’s job gains were revised down to 68,000 from 77,000. Discouraged job-seekers, including those who can’t find work, part-time workers looking for full-time employment, and the unemployed now stands at 14.9%. The only plus side was that the temporary workers number rose by 25,000, but again those are temporary jobs.

Now add to this was the fact that June saw the manufacturing sector contract with retail sales also being weak. Both ISM Manufacturing and ISM Non-Manufacturing numbers were less than forecast. And as the third quarter gets underway, US GDP is forecast to have slowed to 1.9%.

Yet with all the difficulty the US economy is having, the Dollar Index has not fallen. On Friday, the Euro fell once again against the Dollar to close at 1.2283 with the DX closing above 83 at 83.495, nearly the highest in 2 years.
Given that institutional investors are more likely to invest in US Treasury Bonds and Notes over retail customers, it is clear that they have been buying these treasuries all the time the Market has been running back up, quietly, behind the scenes. Now third quarter reporting is about to begin on Monday, with Alcoa reporting after the Market closes. The aluminum producer is only forecast to post a 5 cents earnings per share, down from 32 cents one year ago. Unfortunately, Alcoa, having become the worst performer in the Dow Jones Industrial Average, being down 46%, is looked upon as a bellweather for the rest of earnings season.

Alcoa is not the only question in everyone’s mind as earnings season begins. On Friday, JP Morgan is set to report. Already the $2 billion loss has become more like $4-6 billion. How will this affect its quartly earnings? And more than that, like Barclays Plc, J.P. Morgan is also under investigation for rigging the London interbank offered rate. Barclays paid $452 million fine and saw their CEO resign. How much will JP Morgan pay if similar charges are substantiated? And this time, will Jaime Daimon’s job as CEO be ended?

If Alcoa and JP Morgan do not report well, could this be why institutional customers have been quietly buying up US Treasuries behind the scenes and sending the Dollar Index to its highest in 2 years? In a few days, we’ll all know what’s really going on.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

To understand this, let’s go back to April. On April 30th, the Market reached a double top, at 13279. The previous high was April 2nd. The entire first four months of the year, the Market was rallying, with no let up in sight. The Dow was well above its 200 moving average which was at less than 12,400. Retail customers were once again willing to invest. It appeared that the Dow would regain its pre-2008 levels.

With the release of the TIC report, forecasters fully expected to see some 45 Billion pouring in, across all U.S. equity sectors.

But what the TIC report revealed is not what was expected. In March, the month before the Market reached its double top, equity stock market purchases exceeded $7 billion, showing that, especially institutional investors, they fully expected the Market to keep the rally going.

But in April, the month that the Market reached its high, equity purchases fell from $7 billion to $2 billion. In the private sector where institutional investors are categorized, just $.5 billion. The institutional investors were selling in April.

In March, institutional investors were dumping U.S. Treasury bonds. They could not dump them fast enough, selling $13.8 billion. What a change for April, where those same investors bought over $22 billion bonds.
How did they know that the Market was going to drop 1200 points in a month? Oh to be a fly on the wall in those board rooms. Surely they knew. No institutional investor simply stops their course of action so abruptly without a reason. Who told them in advance?

The problem for retail investors is obvious. They don’t have the inside information that the institutional investors do. They are so often late to the party, and stay far too long. How many were forced to sell in May at a loss because they bought at the high in April? January, February and March the volume was extremely low. It was only really just April that saw the retail investors coming back into the Market, with trading volumes beginning to increase.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

The previous Friday, the unemployment news broke, revealing that just 69,000 jobs had been created. The Market plunged quickly and remained down the entire day. Monday morning, everyone worried that the Market would continue to plunge. After all, it had been down just about every day of May. Instead the Market was flat, holding around 12,100. On Tuesday, the Market was up slightly, certainly nothing to write home about, just drifting, a little up, a little down.

As is the custom before Bernanke delivers his testimony, the other Fed Governors also address Market conditions.

Dennis Lockhart, from Atlanta, began by saying that the current monetary policy was appropriate for the existing outlook he envisions. Only if modest growth becomes unrealistic would further monetary actions be necessary. Bottom line…no mention of QE. John Williams from San Francisco also spoke, but only said the Fed “must also stand ready to do even more if needed to best achieve our statutory goals of maximum employment and price stability.” No QE.

But then it happened. Bernanke’s right hand person, the number two Fed governor, Vice Chair Janet Yellen put QE on the table when she said, “I am convinced that scope remains for the FOMC to provide further policy accommodation”. The Market went wild and crazy, soaring nearly 300 points. There it was, on the table at last.

But here’s the anomaly — something always to be watched. While the stock market was flying high, the best rally day of the year, the Bond market was not sinking. Under normal conditions, traders either buy stocks and dump bonds, or buy bonds and dump stocks. To see both running up — that’s an anomaly.
And what made this anomaly even more evident was the fact that, yes the Market ran up nearly 300 points, but on very light trading. Given the heavy volume when selling in May, light trading was also unexplained. If the Market truly believed the low was reached, there would have been massive buying.
For those of you unfamiliar with the 2 magic letters, “QE”, it stands for “Quantitative Easing”. Here’s the Readers Digest intent. The Feds, at taxpayers expense, buy up toxic assets from the banks, (remember the sub-prime mortages that the same banks were packaging and re-packaging, until they were selling nothing but air) at face value that are all still sitting on their books. Of course, everyone knows that those sub-prime mortgage packages are no longer worth face value, or even half a face, but let’s not get technical. With this newly acquired money, the banks are more able to lend to business and industry, which, in turn, expand. More people are put back to work during the expansion.

But what is the reality? The banks changed their lending policies, making it more difficult for everyone to get loans. The housing / construction industry slowed, manufacturing slowed, just about anywhere money could have been used to expand business and hire more labor slowed.

Even the Fed knows that unemployment has not and will not materially drop. In his speech, John Williams said, “I don’t expect the unemployment rate to keep dropping that fast. It’s more likely to come down much more gradually over the next FEW YEARS.” So if the main purpose of QE is to reduce unemployment, and the Fed knows that unemployment can’t be reduced quickly, then what would be the purpose of additional QE? How could the Fed justify spending more taxpayer dollars on toxic assets? And didn’t the Market know this on Tuesday when Lockhart, Tarullo, Williams and Yellen all spoke? Didn’t all four say the same thing?

So why did the Market’s traders run up nearly 300 points before Bernanke testified? They knew what he was going to say ahead of time. They knew there would not be QE3. They knew Yellen was blowing smoke when she said QE was on the table. Hmmm….have you ever noticed that whenever a company or government has a problem, they always bring out a woman to take the heat, as if no one would beat up on a woman! Like when Walmart was caught with their pants down, bribing everyone and his brother in Mexico, it was a woman spokesperson to answer the questions first at the press conference. Was Yellen the token woman?

How about this for the more “under the table” scenario. The Market had been down the entire month of May. If someone didn’t do something, when Bernanke testified on Thursday, the Dow would have plunged even further, having already dropped over 1200 points from its high and about to break 12,000. So let’s buy the day before knowing that bad news was about to be delivered. The real question to ask is, who did the buying?

Remember this setup! Next time Bernanke is giving testimony, a few days before, get ready to see a Market rally. But watch the 10-year Note and 30-year bonds. If they don’t plunge, know the rally is on, but it will be short lived.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

Not to be humbled by Market insults, you run out and purchase a raft of technical indicators, one after the other. Surely amongst all the trading software available on the Market today, there must be one such indicator, one “Holy Grail,” the key to fulfilling all your dreams of wealth and riches. But what is the reality? All the hype in all the trading websites, couldn’t put Humpty Dumpty together again.

So often we’re told about this indicator not working and that indicator not working, as if an individual technical indicator could account for an entire trading system. Trading is a big subject. As for technical indicators? They are merely individual components of an overall trading strategy, not a strategy in and of themselves.

Read the hype in all the websites. Invariably they say, “high probability predictions”. That’s correct, prediction, not much more than weather forecasts. And if the indicators don’t work for you, well, no problem…the developers are never responsible for your loss. Just move on and buy another indicator.

What makes these indicators so inconsistent? They are all based upon the same data, price, volume and time. Surely by now someone could have come up with an indicator that really blends these three elements into a workable strategy, especially given all the mathematicians who, over the years, have worked on them.

The answer to this riddle is simple…high frequency trading robots programs (HFT’s). In today’s Market, high frequency trading firms represent 2% of the nearly 20,000 trading firms. Yet they account for nearly 73% of all US trades and 40% of all European trades. In 2008, the only computer generated trading came from basket trades executed at 9:30am when the Market opened, and even that was less than 30% of the daily trading volume. In 4 short years, HFT’s have garnered an additional 40% of the Market. Think what will happen over the next 4 years.

Here’s the real key to why technical indicators are no longer reliable. Technical analysis is based upon the belief that there are predictive patterns that follow overall trends, the underlying idea being that traders tend to buy and sell in repetitive sequences. These sequences can be identified through such tools as moving averages, MACD’s, Elliott Waves, Bollinger bands, RSI, ROC, etc. What technical traders haven’t realized yet is that HFT’s do NOT follow trends; HFT’s sacrifice repetition for speed.

Let’s put this into perspective. 1 second equals 1000 milliseconds. Every click of a mouse normally requires 300 milliseconds. In the time it takes to click a mouse, HFT’s will have had their trades filled by the Exchanges…because HFT trades can get filled in 1 millisecond. Their computers are located inside the Exchanges, directly tied to the Exchange’s datafeed. They don’t need to watch the old “tried and true” moving averages or MACD’s. Their only interest is in waiting for a lightly traded Market, ensuring that there is no competition for their trades to be executed. Compare this to a trader watching technical indicators, waiting for the trend to start, watching, watching, watching.

Here’s the rule of thumb. For every 100 miles you live from the Exchange, you’ll need at least 2 milliseconds for your trade to arrive, not to get filled, to arrive. Say you live in California and want to buy some shares at the Nasdaq. You click your charting platform, sending the trade on its way. The mouse click alone took 300 milliseconds and you’ve just added another 30-40 milliseconds for your trade to arrive. By the time your trade arrives at the exchange, the HFT’s that were filled earlier in 1-2 milliseconds, use your trade as an exit for theirs. They bought, and now they are selling. Your executions, late to the party, become casualties of war.

No technical indicator can help you overcome HFT’s, especially if those indicators were developed pre-2008, before the HFT’s took over the majority of trading.

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.

You knew, even before it started actively trading, something was wrong. The stock was to begin trading at 11:00am EST. 11am came and went, with an announcement that there would be a 5 minute delay. 11:05am came and went. No trading. CNBC had announced that at 10:45, the board would open for bid/ask offers. Up to 10:45am, CNBC aired a price of $45, a full $7 above the $38 announcement. But as 11:00am approached, the price began to slide, from $45 to $44 to $43 to $42 to $40. Once the price retreated to $40, CNBC stopped showing the offer price. Instead, to fill the airspace, they showed a handful of people standing in front of the huge NASDAQ board on Times Square in New York, waiting for Facebook to begin trading, as if a handful of people would make the difference.

Once 11:05 had come and gone, CNBC also stopped airing any real news and hoopla. They knew something was wrong. They announced that there were “booking problems”, blaming the Nasdaq, like it was the Nasdaq’s fault that the price was sliding and sliding fast. Booking problems…something very generic. But what was the real problem? Behind the scenes — there was so much selling of Facebook shares.

With that much selling going on, there was one other consideration. The European Market was about to close. If Facebook was selling off big time, let’s not get the Europeans into the frenzy. Even though they specifically announced that trading would begin in another 5 minutes and then another 5 minutes, well before the European Market closed, it was clear nothing would happen until after the close took place. The Nasdaq was being blamed for “computer glitches” causing the delay. But look, was it a coincidence that the stock finally opened a minute or two after the European market closed?

Just after the European market closed for Friday, Facebook began to sell, and sell, and sell. There were no buyers. Even Kramer on CNBC was saying to everyone: Don’t buy the stock on IPO day.

Here’s one question that nagged at everyone: why Friday? Why start trading at 11am EST Friday? Why not Wednesday or Thursday when there could be some follow through the next day? Why not start trading at 9:30am when everyone could participate, including the Europeans? Were the underwriters genuinely afraid of sell-off?

The irony about this IPO is that so many investors fell victim to the hype. Demand for Facebook shares had been unrelenting, surging past supply due to the extensive media coverage. Even smaller investors were in the game…to the tune of up to 30% of the shares outstanding. Given the lackluster low-yields that stocks and bonds have been offering to date, along with the fact that the first two weeks of May drained much of the first four months gains the Market boasted, everyone was anxious to get a piece of the action. Supply was so limited that retail investors were told that unless they had a long standing relationship with one of the underwriting brokerages, chances of purchasing stock were, at best, limited.

For Facebook the company, its senior management and early investors, the IPO was a big time success, raising billions. This should have been a major win for Facebook’s largest underwriters as well, such as Morgan Stanley, its lead underwriter. With fees hovering around $175 million, that’s a nice boost to their quarterly bottom line. But wait, this was a party that no one attended, remember? So how much of that $175 million in fees went to prop up the $38 price? How far would the stock have fallen if not for being bought at $38? Those retail customers that were able to scarf up some of those shares, how well did they actually fair?

Monday the proof will be in the pudding. Will Facebook hold at $38 or will it begin its descent into the abyss? There won’t be Nasdaq “computer glitches” to blame. The hype will be over. Facebook will just be another stock amongst all the others trading live. Will investors continue to sell, or will the retail “faithful” march in and buy up as many shares as they can? Only time will tell…

Barbara Cohen CIO, Shadowtraders, and professional day trader, specializes in teaching students how they can be trading futures with their own trading system and trading strategies. Ms. Cohen has helped hundreds of traders achieve their goals trading. Find out if trading futures is for you by attending one of Ms. Cohen’s Free Webinars. Check out my Futures Trading Articles. For more information, send an email to shadowsupport@shadowtraders.com or call 866-617-2037 today.