Dennis Dick, CFA, is a proprietary trader, and market structure consultant with Bright Trading LLC. He has twelve years of proprietary trading experience specializing in pair trading, crutch trading, momentum, contrarian, technical, and algorithmic trading. His insights into equity market structure have been cited in a number of financial publications including the Wall Street Journal, Reuters, Dow Jones, and Forbes. Dennis is a regular contributor at CFA magazine, and a member of the Capital Markets Policy Council at the CFA Institute. He holds his Business Degree from the University of Windsor with a concentration in Finance and Economics.
Posts by Dennis Dick
Dennis Gartman was on CNBC last night and he was asked the question – What has changed (in reference to yesterday’s selloff). His answer – Nothing has fundamentally changed, but the psychology has changed. His statement hits the nail on the head as the sentiment has indeed started to shift to negative. But the psychology didn’t start changing yesterday – it was just noticed by the mass media yesterday. The sentiment actually started changing last week when investors started dumping individual stocks on good earnings reports. And savvy traders who picked up on this tell, were positioned well for yesterday’s selloff because they were no longer buying the dips, they were selling the pops. Let’s explore the evidence.
Last Thursday, Southwest Air (LUV) reported an excellent quarter with adjusted earnings of $.70 vs estimates of $.55. They beat on the top line as well. The stock spiked up in early premarket trade, but then near the open the stock made a sharp reversal quickly falling a dollar and finishing the day in the red.
On Tuesday, Aetna (AET) blew away both the top and bottom line numbers. The stock rallied sharply in the premarket, but quickly gave back the gains and finished the day sharply in the red.
Wellpoint (WLP) followed suit on Wednesday, rallying sharply in the premarket on solid earnings, but then opening at the high and within an hour had fallen more than 8 points from the open.
Wednesday night, YELP reported decent numbers, the stock quickly rallied 6 points after hours, but within minutes gave it all back. The next day the stock fell another 8 points.
On Thursday morning, both Exxon Mobil (XOM) and Mastercard (MA) reported good quarters. Both stocks again popping in the premarket, but then quickly giving the gains back and finishing heavily in the red.
It is one thing to sell a stock on a disappointing earnings report, it is quite another to sell a stock on a strong report. But that has been the trend for the past week, and that was a tell. The market was telling us from the action of these individual issues that sentiment was shifting. Investors were taking chips off the table despite strong fundamental reports.
Argentina might have been a catalyst that kick-started the masses into selling yesterday, but the smart money was reading the trading action earlier this week and instead of buying the dips, they were selling the pops.
Capitulation is a term used by traders that signifies a climactic end to a recent downtrend in the market, coupled with strong volume and a spike down in prices. This is the event where all the buyers finally give up, and throw in the towel dumping their losing positions. Often, after a capitulatory event, the market starts to reverse and strengthen (think March 2009 when the S&P500 futures hit the 666 low).
But capitulation can also occur in the opposite direction, when all the shorts finally give up and cover their positions, and all the johnny-come-latelys, who have watched the rally from the sidelines, finally hop on board and buy stocks. You could call this event “upside capitulation”. This usually signifies a market top, and a correction or pullback often follows.
I think we saw upside capitulation on Friday morning. On the Premarket Prep show, we were discussing the enormous opening buy imbalances in the S&P 500 components. If you want to learn more about imbalances you can click here, but to put it simply, a buy imbalance indicates that there are more buyers than sellers at the open and the stock will open higher.
Usually when the S&P futures are trading up 5 points (which they were in the premarket on Friday morning), we see buy imbalances, as many of the stocks will open higher with the futures opening higher. But Friday was special. The opening buy imbalances were enormous. They were 10-20 times larger than would be expected for a 5 point up move in the S&P futures.
The institutions that were buying the stocks on this open didn’t just want in, they needed in. Whether it was to offset their options or futures positions (it was quadruple witch), or simply to get more exposure, they needed to buy stocks in a bad way at the open, and the opening imbalances reflected this.
GE had a 5.4 million share buy imbalance (typical for GE is 200-300K).
XOM had a 2.4 million share buy imbalance (to put that into perspective, that is $230 million worth!)
JPM had a 1.7 million share buy imbalance
BAC had a 5.4 million share buy imbalance.
WFC had a 2.8 million share buy imbalance.
VZ had a 2.2 million share buy imbalance.
C had a 2.7 million share buy imbalance.
It was huge buy imbalances across the board in the S&P500 components. Billions of dollars worth. In fact, the imbalances were so large, there weren’t enough stock/index arbitrage players to offset the buy demand in the stocks, and the stocks opened much higher than they should have relative to the futures.
Check out these opens:
GE opened up 53 cents at $25.80.
MRK opened up 91 cents at $56.50.
JPM opened up $1.09 at $61.20.
PFE opened up 58 cents at $32.49
T opened up a ridiculous 71 cents at $34.80.
And the stocks cratered immediately. But not only did they crater, they kept continuing to sell-off throughout the day, and it spread throughout the market hitting some of the high flyers the hardest.
BIIB lost 8%, DDD lost 6%, NFLX lost 4%, TSLA lost 2.6%, GILD lost 4.6%.
This was a key reversal day in the stocks and in the overall market. The S&P index opened right at a new all-time high, and then sold off and closed very weak. Many stocks closed at or near their lows of the day. The ridiculous buying off the opening print and then the immediate sell-off that ensued may have been the capitulatory event the bears have been looking for. We’ll know more in the coming week, but it looks like there is a distinct possibility that the institutions that HAD to be in this market on Friday morning, may have just bought the top.
Update: I had a rant on the #Premarket Prep show this morning discussing this scenario and why the market is heading lower:
Exone Company (XONE) lowered guidance after the bell tonight. 3D Systems (DDD) immediately started getting whacked on the news in sympathy, but Stratasys (SSYS), another sympathy play, was slow to respond.
Some might argue that SSYS lowered guidance earlier this morning and their down move was already priced in, but this was not the case. In fact, the stock could not immediately trade lower on the XONE lowered guidance due to the uptick rule.
Yes, the uptick rule still exists, but it only applies in certain situations. The uptick rule still applies if a security drops by more than 10% (which SSYS did today). So nobody can short the stock without an uptick for the remainder of the day (and the following day).
But this rule actually interferes with the natural price discovery process, and uninformed investors can be punished as a result.
Let’s dive into the details of the SSYS trading action after the bell:
The XONE news breaks shortly after 16:05, and everyone gangs up on the offer at $119.06 to try to short SSYS (myself included). You can see how the offer builds in this image:
Then some unfortunate traders decide to place buy orders for the stock and are executed against the $119.06 offer (My offer was not one that was executed).
These traders are completely uninformed because the SSYS price has not fully adjusted for the news, and cannot adjust until a natural seller sells the stock which happens here:
The price drops to $119, and informed traders gang up on the offer again at $119.01 trying to get short:
Eventually another natural seller comes in and the stock falls down to a price of $116 a few minutes later.
My issue here is with the unfortunate buyer of the stock at $119.06. Had the uptick rule not been in place, the SSYS price would have been able to adjust much more quickly, and the unfortunate traders that bought the stock at $119.06 would have likely gotten a much better price.
This is a good example of why we should not reinstate the uptick rule, and in my opinion the rule shouldn’t exist at all as it slows down the price discovery process.
Dennis Dick discusses “Information Arbitrage” at Bright Trading. Topics include high frequency trading, informed and uninformed order flow, strategy, and tactics for more efficient execution.
Bob Bright, CEO of Bright Trading, Rob Friesen, COO of Bright Trading, and Dennis Dick, CFA, market structure consultant at Bright Trading will be offering a FREE webinar today at 4:15 ET.
We’ll discuss the history of Bright Trading and how our traders have adjusted to the new high frequency trading world. We will answer any questions that you may have.