Monday, May 31, 2010

Flash Crash 1962

On May 28, there was a "flash crash." If you didn't notice it, that is because it occurred not in 2010, but in 1962. Its aftermath offers some clues on what might happen in the wake of this year's flash crash on May 6.

"The stock market careened downward yesterday," reported The Wall Street Journal on May 29, 1962, "leaving traders shaken and exhausted." The Dow Jones Industrial Average fell 5.7% that day, down 34.95, the second-largest point decline then on record.

"The drop took place on volume so heavy," added the Journal, that the "ticker wasn't able to finish reporting floor transactions until 5:59 p.m., two hours and 29 minutes after the market closed."

Like this year's flash crash, the "market break" of 1962 came after a run-up in the market that had led many investors into complacency. In 1961, stocks had risen 27%, with leading technology stocks like Texas Instruments and Polaroid trading at up to 115 times earnings.

Then, without warning, stocks "broke."

Some blue chips, like AT&T, came down relentlessly all day. But others broke with a snap that terrified investors unaccustomed to volatility. Around 2:48 p.m., International Business Machines Corp. crashed like a boulder pushed from a cliff. IBM, which had closed the day before at $398.50, fell from $375 to $365 on four sickening downticks within two minutes, hit $360 six minutes later and bottomed at $355 at 3:17 p.m. The shares had fallen 5.3% in 19 minutes. Less than six months earlier, IBM had traded at $607.

The plunge in smaller stocks like Brunswick Corp. was even sharper. At 3:08 p.m., the company traded at $24. By 3:20 p.m., it had hit $21.75, down 9.3% in 12 minutes. That was 22.3% down from its opening price.

Some of the parallels between the two flash crashes are uncanny.

In this year's crash, many trades, especially in exchange-traded funds, went off at prices wildly different from the orders investors had placed. Likewise, in 1962, "some orders were executed at prices substantially different from those which prevailed when the order was entered," an investigative report by the Securities and Exchange Commission noted the following year.

Some high-frequency traders, which use powerful computers to make markets in stocks, stopped trading in this year's flash crash at the very moments when the market needed liquidity most urgently.

In 1962, high-frequency trading didn't exist, but "specialists" did. By law, specialists were obligated to try to maintain a fair and orderly market for each stock on the floor of the exchange. However, concluded the SEC's report, "At no time during the day did the specialist intervene in sufficient volume to slow the rapid deterioration of the market in IBM."

Even without the Internet, fear spread quickly in 1962. Investors piled into brokerage firms' "board rooms," where wall-mounted boards displayed market prices. "It was standing room only at Merrill Lynch, Pierce, Fenner & Smith," reported the Journal, "with spectators lined up three or four deep in the customers' gallery there."

As the SEC report noted a year later, "The markets' erratic behavior prompted concern and caused bewilderment at home and abroad. The frenetic activity of the break resulted in large and sudden losses for many and gains for some … this break had a strong and immediate psychological impact upon the Nation."

Traumatized investors bombarded the White House with complaints and pleas for help. And they voted with their feet, in what the SEC called a "general public disenchantment with the market." As households slashed their purchases of stocks, 8% of stockbrokers left the business throughout 1962, and "the pinch was felt" even by giant firms like Merrill Lynch, whose net earnings fell by half from the year before.

While investors didn't bail out of mutual funds en masse, they sharply cut back on their new fund investments. It took two years for fund sales to regain their former level.

The 1962 flash crash stepped up public pressure on the SEC and Wall Street to clean up trading procedures. But by the summer of 1968, billions of dollars' worth of trades were going astray every month, and the major stock exchanges had to close down on Wednesdays so brokers could get a midweek breather to catch up on processing delays.

The crash of 1962 is a reminder that markets always have been messy and that investors' morale always has been fragile. What's more, the problems the regulators sought to solve nearly a half-century ago are still with us today. They probably will be tomorrow, too.

Motivational Truths

Friday, May 14, 2010

My Thoughts on the Market

I feel we are in a secular bear market just like 1929-1949 and 1965-1982 where the stock market traded in a range and didn't consistently make new highs. I also believe that if the US government keeps printing money and bailing out people then we could end up like Japan where the stock market stays depressed for two plus decades. The current secular bear market started in 2000 after the dot com crash and is still running its course presently. We are currently in a cyclical bull market during a long term secular bear market fueled totally by the Federal Reserve Bank via the bailout plans.
The S&P 500 stock market index made a high on October 9th, 2007 at 1565 and made a low on March 9th, 2009 at 676. The total decline was 889 points or roughly 57%.
Using Fibonacci retracements which are a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. However, Fibonacci's sequence of numbers is not as important as the mathematical relationships, expressed as ratios, between the numbers in the series. In technical analysis, Fibonacci retracement is created by taking two extreme points (usually a major peak and trough) on a stock chart and dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels. Using the Fibonacci method would give you potential price targets of a 23.6% retracement at 886, a 38.2% retracement at 1015, a 50% retracement at 1120, and a 61.8% retracement at 1225. The S&P 500 has topped at roughly 1220 on April 26th, 2010 which is roughly a 61.8% retracement. Only time will tell if the market moves higher than 1220. I'm not opptomistic. I think the market stays highly correlated to the price of crude oil and the dollar index over the long term. Attached below is the hyperlink to the Chart of the S&P 500.^gspc;range=6m;indicator=psar+bollinger;charttype=candlestick;crosshair=on;ohlcvalues=0;logscale=on;source=undefined

Thursday, May 13, 2010

Traders Audio from the Crash on May 6th

That's great audio from the futures trading pit at the Chicago Mercantile Exchange. The activity definitely cleared out some stops below and now the market should move to around 1300 before collapsing again. That's complete speculation on my part using a 68% Fibonacci retracement of the market move off the March 2009 lows. Of course Goldman Sachs has reported no losing trading days last quarter which is statistically impossible! Who says the market isn't rigged. You only have no losing trading days if you are holding a illegal competitive edge.'-expense-485282.html?tickers=xlf,%5Edji,%5Egspc,gs,jpm,bac,c

Friday, May 7, 2010

Cognitive Bias Song

You might have friends who are guilty of many of these biases. In trading many professionals are guilty of these biases. I'm guilty of a representative bias because I feel most trading professionals are always bullish on the market. I've been guilty of many of these. Right now I'm completely guilty of anchoring bias and I feel the market will crash down below the March 2009 lows. Today should be an interesting day in the market.