Why? The 1000 point Dow days!…October 5, 2020

                                    ….. What  so few understand…..but they should…..

Some of the most knowledgeable yet still uninformed investors and many media people do not understand a key factor that has carried and supported the stock market (and too many individual stocks) to such overvalued levels for exceptionally long periods.

Moreover it has shaped the incredible up-down volatility. We will try to explain how the market operates and perhaps one will understand 1000 point up days and 1000 points down days in the Dow Jones. There are very valid reasons.

These are first hand observations by me and others with whom we have worked with in the investment industry in Montreal and New York.

In the nineteen seventies through the nineteen nighties, we estimate that approximately 40% to 70% of the stock market volume was normally longer term investment volume originating from institutions (funds, pensions etc.) and private retail investors. There is no official available tabulation for whom or what institution each trade was for so we estimate as many large orders must be broken down to facilitate an entire order. However, we feel that we are very close in our estimates.

When we invested for clients, we worked closely with the exchange “specialists” and the “market makers” for many years who gave us extremely insightful feedback and opinions.   

             

                               A significant change in the market(s)!!

Today it is reported that on some days approximately 80% to 90% and even LARGER PERCENTAGES  of the total overall stock market volume is derived from the “trading oriented” categories such as high frequency trading, algorithmic trading, day trading and hedge funds. It is not the “old time type”investing as we knew it, rather it is short term oriented trading attempting to catch short term price changes. And again we are not referring to the gross total of individual trades but rather the total volume of all the trades.              

                                  

For example, for a specific common stock we may see twenty individual orders for approximately 200 shares each of a stock totaling 4000 shares. Those smaller size trades could be handled satisfactorily by a specialist(s) in the past with the security to some degree of the then “normal spreads” between the bids and offers.  

Then we may also see a large sell order or more large sell orders from a high frequency trading firm for 100,000 shares that could be a short term investment….so the twenty orders that would total 4000 shares are minimized by the one order for 100,000 shares. No specialist generally speaking wants to or even can “step in” with his own firm’s money and buy the 100,000 shares with its obviuos risk. Thus the high frequency trading firm’s order is twenty five times the volume of the retail trades or 96% of the volume! Again, it is the total volume we are focusing on not the number of transactions. The volume of transactions are simply  too large for a specialist firm to purchase and put in their own firm’s account.

A single large sale of 100,000 shares of a stock or more is generally too risky for a market maker (specialist) to step in with buying support with the firm’s capital; the risk of an enormous decline in the stock’s price is always there….. One large order can tip the scale particularly in a harsh downturn and lead to huge losses for the firm. One should note that the large succcesful specialist firms of the past are no longer in existence. The “no upticks required” and minimal spreads for the most part finished them off.

A large volume transaction such as that described in the prior paragraph can be a problem coupled with another factor which is an alarming part of today’s market. That other factor is the rule that upticks are no longer required to sell stocks short which allows stocks to be literally pounded down with borrowed shares.  And they do just that! They want the stock’s(s) price to be pounded down as low as possible in order to cover (buy back) the shares that they shorted for their own profits.

FOR EXAMPLE.. Suppose that during one hour of volatile trading several large institutional shareholders want to sell a total of one milliom shares of a specific stock that is selling at for $65 a share.Note well that in a declining market one can often expect a huge volume of stocks for sale. So who is going to step in and buy the shares that are for sale? If the market maker firm (specialist) should step in and buy the shares it could face substantial losses as the decline continues.

Multiply that times all the shares that are trading and major losses mount. It is easy to understand why there are no longer the specialist firms of the past today. Note that if the specialist firm had bought those one million shares and the stock declined $2 from their purchase price, it would cause a loss of $2 million at least for the interim.

Just an ugly rumor? Many experienced investors and professional traders believe that the unrestricted shorting of stocks without the prior and long held requirement of upticks for any short sales was above all else created, engineered and plotted to benefit the banks’ and brokerages’ profitability-not the investing public nor the corporations themselves that trade on the stock exchanges in the U.S. and Canada. What else is new? Oh yeah, just another ugly rumor!

PART TWO WITH EXAMPLES WILL BE COMING HERE