Archive for September, 2010
A Quick Note on Gold and the Markets
Posted by Jody Eisenman | Filed under Uncategorized
Throughout history, investors have flocked to gold in times of economic instability. The thought has always been that in the event a nations’ currency is devalued, something precious like gold will always have value. Therefore, it behooves us to look at the price of gold to see investor sentiment. Quite simply, gold has soared at a level unseen throughout history. At the turn of the millennium, gold was selling around $300/oz. By mid-2008, the price was up to around $700/oz. However since then, gold has exploded in price, with current levels above $1300/oz. What is driving this?
There is certainly great concern over the state of world economies. Readers of this blog know about the perilous state many countries are in due to extremely high debt levels. Many nations are considering weakening their currencies, which lead investors to turn to gold as a strategic alternative. Many gold dealers are charging high premiums on gold coins, and some are even out of stock due to surging demand. Is this a sign of coming economic turbulence, or simply a great bubble ready to burst?
In the meantime, the stock market has staged an impressive September rally. As of yesterdays’ close, the DJIA is up almost 850 points for the month, or over 8%. Better than expected earnings have spurred this rally. Of course, this rally is in complete opposition to gold prices, which would seem to anticipate economic instability. In line with this, Meredith Whitney came out yesterday and repeated her negativity on the financial stocks. In addition, she believes that the individual US states could be in line for the next financial crisis, something I believe as well. Most states, especially the larger ones like New York and California are heavily in debt. However, unlike the United States, they have no ability to print money. Instead, states budget deficits rely on their ability to continue to peddle bonds to investors. Although everyone agrees that these deficits cannot continue indefinitely, it is rare that a governor or state official will stand up and demand the balancing of the budget. The reason for this is simple: balancing budgets mean raising taxes and/or cutting essential services, something that it is very unpopular if you want to get re-elected. Will this crisis ever hit the fan?
From Market Making to High Frequency Trading: A Brief History (part 2)
Posted by Jody Eisenman | Filed under Uncategorized
I’m going to share with you something few investors actually know. Most people are familiar with the market crash of 1987. What most people don’t know are the circumstances regarding the over the counter market. First, a bit of background. October 19, 1987 is now known as Black Monday. The stock market had been slowly declining since the beginning of the month. On Wednesday October 14, the DJIA closed down 96 points, which was almost a four per cent decline. The next day, we were down 57 points, and the following day (Friday), we dropped another 109 points. Thus, in three trading days we were down 262 points, or over 10 per cent. Investors were skittish over the weekend, as the market decline accelerated into Fridays’ close. However, this was just the prelude to Black Monday. On that day, I remember sitting in my office at 14 Wall Street, and listening to the intercom on my desk that told me pre-opening information. Usually, they would say things like “We see small sellers”. This was before the internet and CNBC. On this day, all I heard were massive sellers coming in. By the time we closed, we had lost 508 points, or over 22% off Fridays close. It was pretty shocking. I still remember coming home and watching the news, where it was the lead story on every channel (there was no cable then!). The newscasters then stated that everyone looked to Asia, to see how the markets there would open. Of course, the markets plunged in record volume. One guy in my office attempted suicide over his losses.
However, the real fun came later. The way trading was done was through market makers as described yesterday. However, virtually all trades then were done via telephone in those days, and not electronically as today. Therefore, in order to consummate a trade, your trader had to physically call the other market maker in order to confirm the trade. Pretty soon, the large firm market makers like Merrill and Smith Barney realized that they were facing huge sell orders from their brokers, Normally, they would turn to market wholesalers (NITE does a lot of this today) to sell their positions. However, the wholesalers soon realized the magnitude of the decline, and they were unwilling to take in any stock. Therefore, in many cases, they simply refused to answer their phones. However, no one moved their markets. To put this in prospective, I tried to sell 1500 shares of a stock called Phoenix Reinsurance on the Tuesday following the crash. I could not. My trader would not take the stock, something that would not happen today. The stock was trading around 14. I finally sold it 10 days later at 10! I know that sounds crazy, but there were no other options. Essentially, the entire over the counter market failed. Investors could not sell, and the prices on the screen bore no connection to reality. Had investors at the time realized this, it might have caused a severe panic. The regulators knew they had to act.
In my next post, I will discuss the changes that were made.
From Market Making to High Frequency Trading: A Brief History
Posted by Jody Eisenman | Filed under Uncategorized
I am sometimes amazed at the incredible changes that have taken place in the trading of stocks. .I can still remember a day in the mid 1970′s, when I worked as a cold caller at the now defunct Lehman Brothers (I still have their hat, though).On that day, trading volume rose to an astounding 31 million shares, well above the capability of the ticker tape and quote system (anyone still remember Quotron machines?). The tape ran about 90 minutes late, meaning that the prices you saw on the screen were already an hour and a half old. To put this number in prospective, AVERAGE trading volume was 200MM shares per day by 1992; the current number is over 1.5BB. Trading on the NYSE used to take place as follows: An investor would place an order with his brokerage firm. The broker would wrote a ticket and walk it to the trading room. The room would enter the order electronically, where it would be sent down to the floor. On the floor, there would a trading pit, where you might see a bunch of guys (there were very few women floor brokers on the floor in the 1970s) in a circle screaming out orders. Somewhere in the center of this pit would stand an individual known as a specialist. The specialist had two functions: to maintain an orderly trading market, and to commit their own capital in case there was an overflow of buy or sell orders. As you can imagine, being a specialist was a high risk/high return job. Anyway, when the order was executed, it would be sent back to the broker, and the salesman would wait to see a paper confirmation. He would then report the execution price back to the client. Today, this entire process can take place in microseconds.
Unlike the NYSE, trading on the NASDAQ over the counter market was handled differently. Unlike the NYSE, NASDAQ had no physical location and no specialists. Instead, trading was executed through a series of brokerage firms called market makers, who would buy and sell for customers, as well as for their own accounts. There used to be a sort of “gentlemen’s rule” that among the Big Boys (like Merrill Lynch, Lehman and Paine Webber) that market makers for the more active stocks would generally be good for (meaning willing to execute) transactions for a minimum of 5000 shares. Thus, if a stock was trading say 24 bid by 24 1/8 offer (there were no penny quotes in those days), an order to purchase up to 5000 shares at the market would be executed at 24 1/8. Many traders made a good living simply trading the spread. For example, if a market maker simultaneously received an order to buy 2000 shares and another order to sell 2000 shares, both at the market, the MM would execute the buy at 24 1/8 and the sell at 24, thus pocketing a quick riskless profit of $250 for himself. Incidentally, this is what prompted Bernie Madoff to start his market making business. Madoff might execute that same buy at 24.09 and the sell at 24.03, thus giving each side a price improvement of about three cents. He would still keep the difference, but it would only be about half of what the big boys charged. An important note was that unlike a specialist, market makers had absolutely no obligation to commit their own capital. Therefore, if a stock had a heavy dose of sell orders coming in, the market makers would only buy stock based on client orders. After that, they might all disappear, dropping their bids lower and lower. The same could happen on the buy side. As such, over the counter stocks tended to be more volatile than their NYSE counterparts. In addition, virtually every over the counter transaction took place via the telephone. This became crucial in October 1987. Tomorrow, I will describe the problem, and how the market essentially failed.
