First off, I would like to address the situation we have now...
Of a market where cash levels amongst money managers
are at historically low levels... (i.e. they are fully invested)
According to the concepts you have presented, this would
create one of the most bullish situations possible, because
there is relatively little money available to "bid" the market,
No. You don't have it quite right. It cost nothing to put bids under the market.
which would explain the shallow nature of recent corrections
which nearly always seem to end before they have really
begun. With fully invested positioning, one would think the
book would be above the market as these managers look to
take profits and reallocate funds as the market rises. And
You sound bearish. They aren't. They may be cautious, but they aren't bearish. They get bearish near the bottom. They create the bottom when the realize they're bearishness by selling.
as long as these funds are reinvested "at the market" (i.e.
not sitting on a limit buy price), then the whole process
should perpetually snowball and feed upon itself. Do these
concepts ring true with you?
The book is thin above. People don't want to sell. They see we just went to an all-time high. Why sell? People, public, and institutions are all acting the same way. Who wants to book above and trap out? People are booking below in order to catch a pull back for the inevitable rise. They have been well trained like other Pavlov's dogs on the down side. The marginal demand has to be supplied by specialist and market maker. On balance these two are being forced to short more and more to the public demand because there isn't offsetting market orders to sell to meet the demand.
The institutional cash position has little to do with this mechanism. That's invested position, not positioning money. The averages are determine by the trading noise at the margin. That's the net positioning flow. When there is major investment change you get sustained price translation like last summer. Not much cash was built up by major institutions because the smaller ones caused such rapid damage that the big ones couldn't extract themselves in time without realizing major losses. The FED pump-up in the fall enabled them to paper erase much of the loss, but it also emboldened them to not only stay in, but to further extend themselves.
The sell-off in February lacked conviction so there wasn't enough market order sales to explore the downside. We are not talking about a thin market with an extended bear base behind it, we are talking about a very liquid state that attends the early phases of a general market top. As the top broadens, the market becomes illiquid. FED reassures the stock market with its regular coupon passes knee jerk response to a weakening in the TYX.X. That isn't institutional cash, it's government welfare. That means there isn't the tendency to pull bids as there was last summer. So whereas you get some downside that picks up the nearby bids below, the action falls into a temporary FED-provided pool of cash. When there is market order to sell conviction and bids are pulled and FED takes the pool away, you get Oct '87, hyper-illiquid state. This is not the state of the gold market currently.
Now I would like to address how this process comes to an
end. Obviously, inverse events that occur at bottoms must
take place, which you have already adroitly discussed in
your many posts on this subject. So to identify the end, one
would want to look for a situation where exuberance and
jubilation climaxes...great news is released on the
Already happened in the gold market, 9/1/98, which marked the KT boundary between the era of "disinflation" (slowing of inflation) and reflation.
markets.... everyone is so sure the market is heading
dramatically higher that no one is willing to sell it. And the
This has occurred several times in the stock market. Bonny Bear drew my attention to a stock, "OTMC", whose chart is well-correlated to the money structure under the stock market. You will see the several major market tops the intrinsic market has seen and they coincide with emotional sentiment peaks. To appreciate in what bad shape the stock market is, check OTMC's chart.
johnny come lately's are a little nervous about buying into the
spike up that just occurred when everyone "realized" the
market was heading much, much higher, and couldn't
possibly go down, so the johnnys put their limit orders just
below the price. With the "book" now below the market, it
begins to turn.
Yes, but these things take time and aren't straight line. As you know straight line or translatory moves are fairly reliable against which to take a contrary stance once capitulation is in place.
Those with huge profits see the market turning, and begin to
dump at market to lock 'em in, and down she goes. These
profit takers decide they want to buy back in at a point
significantly under where the market currently is, so the
"book" continues to go lower as more profit taking occurs,
leading the market lower. The common joe is watching this
Surprisingly, everyone including me is a "common Joe". We all hate the democracy of free markets.
whole process, and is in shock and disbelief that this market
that everyone was praising a short time ago is now
collapsing before his eyes. He is stimulated and motivated
to buy now because he missed the huge multi-hundered %
move up, and has always heard you should buy on dips, and
sees the market at a big discount to what it was trading at
just a few days ago. So he empties his bank accounts and
piggy banks, puts his market orders in to buy, and the
market bounces temporarily as the masses do likewise,
giving him a quick profit and making him feel good about his
decision.
That is the mechanism.
But more profit takers who missed their first opportunity to
sell are now selling at market as the price rebounds, once
again raising the cash on the sidelines looking to buy the
market at significantly lower levels. With others too scared
to sell these "straight-up" spike bounces, the limit sell orders
quickly dry up, leaving only naively enthusiastic buyers ready
to buy the first pullback with their limit orders. With the book
now completely below the market, the slide resumes.... and
so forth, gutting the naive and simple, who finally relinquish
their positions when pure and raw panic set in... which is
about where those well placed limit buy orders are located..
<g>.
Correct.
So i would ask you... Do you see a coordination of activities
here... Where the "Good news gas pedal" is floored by the
financial media to meet the interest of certain well
connected players who look to "goose a market" before
they reverse positions? Or is this just the natural process of
the market, with no one in particular to blame, designed to
devour the substance of the naive and uninitiated....?
It is a natural process since it is extremely difficult to know just what state the market is in. You'll find the press is always a posteriori. They try to "explain" why price moved. Sometimes there's no apparent reason so they have to grasp for straws and blame it on obscurities like Miyazawa flipped AG the bird on the way to Dulles and so the market gapped down 2000 points. The public prefers to believe the myth that there is a giant conspiracy being cooked up by trillionaires who control the planet earth and hide out in glass and steel towers. Much to the somewhat believing billionaires' consternation when they want to join up to extend their wealth, they find there is no such animal and that the entire enterprise flies by the seat of its pants. That means a beginner has just as good of a chance as the billionaire to be successful. This is the nature of democracy and it is the last thing you'll ever convince the little guy is true.
You have spoken much of the impact of limit orders, but
what about market orders? Wouldn't you agree that market
buy orders are a sign of healthy continuity in a bull market,
and vice versa for a bear market?
Bear markets are created more by institutional persisting in their entering of bids below the market than by market orders to sell. The market orders are in general net zero in effect unless they are bunched and cause a translation when the other side pulls away from market order entry in the countervailing direction. The market order action is then either directed to the book or in extremes, to the market maker.
Sometimes the market maker won't provide the continuous market that is their job. In Oct '87 the specialist refused to do their duty and so a 100 share order would cause, say, IBM, to drop 60 points. The specialist walked off the floor in protest of their favorite sidecar, program trading which had made them so much money previously. The latrine orderly was the one on the other side of the IBM 100 share trade. The specialists could have made tons by just doing their duty and obeying floor rules, but like the public, they're too smart for that. They know what they need to know and they think they know where markets are headed. Those specialists and market makers with that attitude don't last. They get cleaned out just like the public.
Finally, I would be interested to know if you have defined
other characteristics that may be helpful in identifying the
end of a trend. Ones i've identified here include extremes in
sentiment, obvious "goosing" by the financial media, climax
price moves accompanied by climaxes in volume, shock and
disbelief of popular sentiment in the new trend, and of
course the all important shift in the "book".
I included the comments above about what can happen to a specialist who bends floor rules, who tries to use the book to get an advantage. The market is set up to make the specialist money by forcing the specialist to buy or sell at market extremes. The specialists don't want to do that. They are like everyone else. They can see the market is headed straight up or straight down. Doesn't matter how many years of experience they have. As soon as they don't do their jobs, start wandering into a belief that they know this and that, their expected return starts falling. It teaches you "pretense to knowledge".
The shift in the book is gradual and market makers suddenly see that they have been pushed to be net short or long. They can't use that information because they don't know if the trend has ended. They can only say that they are getting more and more short or long on balance. It makes you uncomfortable to be somewhat short like now. The market has forced you there. The ups and downs force you to cover shorts when brief downside spells are illiquid and you have to cover your market induced shorts below to maintain price continuity.
Nonetheless, at market tops the market maker is on balance short and the psychological effect is that it causes you to expect to see the institutions come in One More Time and run them against you. This is a fear syndrome that you must learn to manage and resist. When effective specialist short interest is high you know the specialist is sweating. You won't see specialist short interest change these days like you did in the past because the specialist is effectively hedged in the option markets so the shorting may be occurring in the derivatives of the issues handled. There are other reasons why the traditional figures don't work too.
Because of this the only way to get an assessment of the market state, the elasticity with respect to marginal supply or demand, which is a representation of the book state and on-balance market order flow, is to analyze every trade. Even if you have the raw every trade data, you have to have an analytical machinery that enables a proper assessment of the market state. As in quantum mechanics there is no continuous evolution parameter that tells you that if you have a set of eigenstates, then in the next time slice you will have a state configuration up to probability density, so you know the certainty of the persistence of state. No Markov chain of previous states can give you the next state space. You only know that the instantaneous state is more or less stable. When integrated back the differential state gives you an average state. Doesn't tell you what markets will do, just tells you how far out of normalized equilibrium they are and hence potential risk, not calculated risk.
Other kinds of anecdotal evidence like all the traditional sentiment measures only tell you that people have degrees of belief. A degree of belief can validly stay in place a long time. Thus they aren't of much value. They're of no value trading, but nothing is since trading is a negative expected return game.
The only reliable way to make money is to identify something that is cheap when there are changing conditions that imply it may no longer remain cheap. Another way is gambling on new. Both require buy and hold. The latter requires buying without looking and the former requires accumulation at ever higher prices.
In this business it is necessary to get evidence and evidence is always probabilistic. The only evidence available is what people are doing. Right now the DOW industrials are near an all time peak, yet other averages aren't. When you look at DOW TRAN and DOW UTIL, you don't like what you see. Obviously UTIL is reflecting what is happening in the bond market, but that can't be good news. You don't try to explain these things away. When you see a divergence between these indicators in what ever direction, you have to take it under advisement. They don't say the Industrials are headed for trouble. They could hang up here for months just like 1972. We have had no bear market since '73 - 74 so many of these indicators are long forgotten. Like Don Worden said long ago I like indicators which have the ability to contradict. There's too much noise in sentiment to sift out of them that ability if it is there. |
