So Exchange Traded Index funds and the $1.2 trillion invested in them have increased volatility for small cap stocks making the whole IPO process less attractive for many founders of U. S. tech companies — our kind of companies. It’s not the end of the world but has been a downer of sorts for both the market and the tech industry for the last decade. What’s to be done about it, then?
“The problem as we see it could be 80-90 percent contained if only Exchange Traded Funds were subject to the same sort of trading circuit breakers that were imposed by the SEC on regular shares after the Flash Crash of earlier this year,” says Bob Litan from the Kauffman Foundation.
The fact that such circuit breakers haven’t already been imposed, stopping trading altogether when things get a little too crazy, makes no sense at all, at least not to me. What’s good for the stock is good for the index that trades like a stock. So do it.
The better question, though, is how do we actually benefit from this situation? How do we — smart nerdy we — make a few bucks on these ETFs that aren’t going away?
I have a plan.
Here’s where it might be a good idea to go back to my last column and read or re-read it so I don’t have to write that stuff all over again. Notice the comments, too, since those folks are far smarter than I am.
So we have this market that goes up and down based on, well, something (nobody is quite sure what) but smart traders can make a good living from it, so why can’t we? I think we can. I think we can make an extraordinarily good living from it simply because much of the Index ETF volatility has nothing at all to do with the individual stocks contained within the index. The price goes up or down for whatever reason and the ETF’s — huge institutional investors in their own rights — are required to rebalance their portfolios to reflect the new market values — values that are, for the most part, artificial.
As a result, shares of the Acme Transistor Company go up or down when it makes no sense for them to do so if you know much about the Acme Transistor Company. Because the bozos running the ETF that is the largest shareholder in the Acme Transistor Company by definition know nothing about what happens there. They simply don’t see it as their business — a very un-Buffettlike way to invest.
Warren Buffett, now that his name has been dropped, wouldn’t pay any attention to this because, as a value investor, he completely ignores this kind of volatility. And as a huge investor, he actually ignores these entire companies because there simply isn’t any way he can stuff enough of his money into any of them to satisfy Berkshire Hathaway’s hunger for shares.
If you are buy-and-hold, then by all means buy-and-hold. But if you want to try and play the game a bit, here’s what you need to remember: for intrinsically good companies this is a zero sum game. Prices that dramatically dip will eventually rise again. And those that dramatically rise will eventually dip again, absent any real news.
Become a specialist in a few little companies within an index like the Russell 2000. Follow both the rumors and the news. If the stock swings wildly and there is no news, no rumors, no insider head feints, no reason at all for that to be happening other than that when elephants fight the grass is trampled, well that’s actionable. Buy or sell as needed, maybe (definitely!) get some leverage by trading options. Short the stock if it is going up or go long if it is going down.
What we have here are two different trading universes and each is simply noise to the other. When you have a sense of the rhythm of an individual stock you can trade on the ETF noise. Rhythm and noise — it’s an inter-dimensional trading algorithm that actually works.
Weird, eh?
I suspect someone will develop an algorithm that tracks something like the stocks in the Russell 2000 and not only identifies these swings, but alerts investors for investment opportunities. If it works, and the programmer can monetize the transaction – then it’s win/win for everyone!
win/win for awhile
For those with short memories: it was value stupid trading that *caused* the Great Recession (which is no where near over, by the way). Wall Street is close enough to a Casino; there’s no Good Reason to urge folks to ETF roulette. Now, is there?
I suspect the “gotcha” in the middle, the something undefined that moves markets with no data, is manipulation. and if the stock is under five bucks, bet on it, but only what you can afford to burn this week.
manipulation? yeah, also called “pump and dump.”
some Wail Street slick is looking over his stock charts for something that leads or lags the industry with no real differential from other companies. finds that say, Acme Germanium is half a buck below Universal Silicon. there isn’t a dime’s worth of difference between them (except maybe bias levels, ha ha.)
so the slickster goes to work. his tip letters, the radio show, visits on TV roundtables, the website pay wall… all are “AGER looks poised for a breakout and a run, I’m in 10,000, don’t miss the bus.”
yeah, he’s in another 2,000 every time the stock rises two cents from somebody buying 500 shares.
keep pumping the stock until it’s reached the Critical Mr. Slick Number. maybe the slickster has had lots of luck once he’s gotten at least 80,000 shares and the sheeple raise the price 35 cents.
then… the slick sells. dump 70,000, hold 10,000 in case there is a second rise. he’s cleared his customary little tickle from the dummies, and the stock drops 60 cents, screwing all his disciples. it might bounce a little back, in which case the slick can dump his last 10,000 at the price he paid, and nail the coffin on the hopeful.
that’s the pump and dump. on cheaper stocks, it’s an inexpensive game, and if you can keep over a dozen balls in the air, it’s a nice steady income.
IMPHO that’s your unexplained market volatility.
the big boys use computers and run hundreds of thousands of shares at a time. to the investment banks, it’s hidden in the daily trading needed to make customers whole in an instant at market, and if there’s a delta-trade between buying low in the morning and selling higher in the afternoon… well, you learn fast, Grasshopper.
Cringe:
All I can say is: you need to be committed. This column is laughable.
“What we have here are two different trading universes and each is simply noise to the other. When you have a sense of the rhythm of an individual stock you can trade on the ETF noise. Rhythm and noise — it’s an inter-dimensional trading algorithm that actually works.”
Deeply, deeply sad, eh?
Thats all you can say? You can’t be more constructive?
Thats laughable.
Thats all YOU can say? YOU can’t be more constructive?
People,
Here are some tips to help any brave soul who wants to try trading this opportunity.
1. Use only risk capital — that’s money you can lose without adversely affecting your lifestyle.
2. If you follow investment advisory services, don’t be concerned if they don’t all agree. No one can be relied upon to know the future. (See item 4 below for when to take a position.)
3. Prepare a trading plan before trading a particular opportunity. Then you can make all your decisions when you aren’t affected by your emotions or crowd behavior.
4. Take a position only on a breakout from the established price range.
5. Limit your losses and let your profits run. (These calculations should be made in your trading plan, per item 3 above.)
Good luck.
be careful with #5 if it’s in biotech, or any small cap. They like to issue secondaries on any bit of price rise.
Hi Bob,
Isn’t your proposal quite similar to what a market maker does? So, you’re proposing a market maker for small-cap stocks?
If this kind of strategy were possible, “big money” would already be doing it. This would influence the stock prices, negating some of those opportunities over time.
It would be unfortunate if small investors tried this and lost some money. It could be tragic if they tried it and made money (leading to ever increasing gambles).
Am I correct in assuming that “exchange traded funds” are the same as the “closed end mutual funds” that have been around for decades?
Mr Efficiency says, “If this kind of strategy were possible, ‘big money’ would already be doing it.” I disagree.
The whole reason this idea could work is because it requires specialization in particular stocks. It is by its very nature a somewhat risky and, more important, highly specialized investment approach. You need to know a lot about the particular industry and the particular company that you’re following.
Big money doesn’t work that way because it can’t. In order to have a very large portfolio, you can’t know that much about the many different companies out there. So instead you have to use second-order indicators — various financial indicators, the trends in the industry, and so on — plus what is really a third-order indicator, which is what everyone else is doing. Big money _used_ to work on the principle Bob is suggesting, back when large brokerage firms had huge staffs of analysts who knew particular companies very well. Some of the large brokerages run TV ads that claim they still do this, but it’s poppycock: institutional shareholders would never put up with it. The quants won years ago, and there’s no hope that the industry will by and large return to specialized analysts with a lot of industry knowledge. By definition, the quants are right in the long term, and so they’re always going to win out. Also, setting up a computer program to generate all this money for you is too beguiling, compared to relying on mere knowledge.
What Bob is suggesting, in fact, is that people invest the way (e.g.) Vanderbilt made quite a lot of his money: by noticing when the stock market is reacting the wrong way, then buying things up ’til (or, in Vanderbilt’s case, so that) the price runs the other way, and then taking some profits.
I have no idea whether this will really work if a lot of people do it. But if only a tiny minority of people do it, it probably will work for them. (One could argue, of course, that this is just contrarianism at its most refined.)
Yeah, Benjamin Graham published this idea back in 1949.. Nothing new here.
Buy low, sell high. How’s this any different other than it’s purely a speculative market? It’s a game best played by those with deep pockets who can influence the speculation.
Following this system, the easiest way to end up with a million dollars in your account is to start with two million.
gaming is gambling
It’s not gambling because you KNOW about the company your investing and the price is wrong so you sell and buy. Its how people use to invest but over a shorter term.
Sorry, you’ve descibed gaming. Doesn’t matter what people used to do or still do now. the definitions are the same.
nick, you only KNOW if you are trading on seriously important privileged information. that’s illegal.
everybody else is betting against the machine, and every brokerage has the same basic machine with its own little tickle. remember the “noise” report a few months ago, in which a geek proved every broker’s wire to the exchange had a regular noise pattern, different to each brokerage, which is theorized to be unique to their testing individual issues a touch at a time to gauge whether they could generate a run up and pull a quick pile of cash out of the sheeple?
and you want to play statistical games against the guy who makes the first X or O on the tic-tac-toe board?
somebody else determines whether your method is a loser. that somebody else makes ten million bucks on a slow day busting methods.
Betting against stupidity is never gambling.
Website feedback
RSS feed for audio seems to have stopped updating after “The Chinese Decade”
https://www.cringely.com/feed/podcast/
Wow. Bob, you are describing one of the things in Phil Town’s book, “Rule #1 investing.” Learn to evaluate your “M”s (Moat, Management, … Read the book) and you’ve got a solid investment strategy.
As Phil said, (I paraphrase) big money *can’t* do this — they *are* the Market.
I like the Art of Noise cover… you always did look sort of like JJ Jeczalik.
It’s generally not a good idea to ride a stock down, which is why this strategy looks great in a retrospective analysis but poor prospectively. Entering trades that don’t make sense when they are increasingly not making sense is what sank Long Term Capital Management. Most people who try to do this surf on the increasing volatility using hedged or naked option strategies, assuming pricing inefficiencies in communicating information between options and equities markets, or speculating that pricing models driving options demand are based on a historical price model that no longer drives trading.
Two bad things can happen to companies whose stocks are declining inexplicably:
#1: There may be good or bad news that someone knows but no one else does — a government contract that goes a different direction than anticipated, a bank about to change its rating, etc. Sometimes these don’t make it into the rumor circles you are in.
#2: A falling stock can have real implications, even if it doesn’t reflect any change in the company. For example, a company may violate debt covenants through falling share price, or may drive other major investors to sell to meet margin calls.
FOR EVERY STOCK TRADED THERE IS A BUYER AND A SELLER, THE BUYER THINKS IT IS GOING UP AND THE SELLER THINKS IT IS GOING DOWN AND AT LEAST ONE OF THEM IS WRONG.
A STOCK CAN GO SIDEWAYS AND THEN THEY ARE BOTH WRONG.
MOST PEOPLE WHO BUY STOCKS ARE ACTUALLY GAMBLING, THEY’RE USING THE WRONG INSTRUMENT. OPTIONS ARE THE WAY TO GO. SO LONG AS YOU UNDERSTAND, SOMETHING LIKE 90% OF ALL OPTIONS TRADED WIND UP EXPIRING WORTHLESS.
WAY TO GO LENNY DYKSTRA, WOO! GO MAN GO.
it’s not as hard as you said. go with companies that you already are expert on. For me, that’s a lot.
Overheard while at an interview for a job in big pharma “uh… chirality ?”–>result, bought sepracor when it was first available.
I really liked my diamond rio–> bought apple stock when they began to have an mp3 player that was ready for mass appeal.
starbucks utilized industrial quality controls on coffee brewing…bought before they expanded to the east coast.
archer daniels midland, J&J, and I don’t know how many other companies have real value and real embarrassments. they go down 20%, I buy.
sysco seems to have a monopoly on food logistics at the hospitals I work at.
everybody out there is an expert in their own field. try looking around.
Sounds like Seykota’s “funny mentals”:
“Fundamentals that you read about are typically useless as the market has already discounted the price, and I call them ‘funny-mentals’. However if you catch on early, before others believe then you might have valuable ‘suprise-a-mentals’.”
Everyone out here is also heavily exposed to their own industry. If that industry takes a crap, they lose with it. So “investing” or trading in that industry adds to their risk.
Here’s a thought. Put together an ETF that invests in all IPOs. Invest x% (2-5%) in every IPO. Hold for one year and sell.
Call it the IPO ETF.
If you can’t beat em… join em.
Are most IPOs up or down after a year?
It doesn’t matter if you are the one who put the ETF together and takes 1% or so of the invested capital. That’s also the role of the house in Las Vegas, eh?
I am very impressed with all the truths created here. I can assertively say that I can connect to this as well. I wish others would take the time to read this as well as I did.
WELCOME TO MY CREESTALL BALL CHAMBER…(AKA JOE’S INTERNATIONAL FERTILIZER SOCIETY WHERE HITLER’S AND EVA’S ASHES ACTUALLY PROVED EVEN THOSE TOTALLY DEVOID OF EVEN ONE ANGSTROM UNIT OF GOOD, PLANTED UNDER A FRUIT TREE DID SOME REAL GOOD)
HEY BOBBERS ALL A QUESTION: WHO WILL TAKE A PAY CUT NEXT YEAR? ANSWER; NOT NOBODY!
WHAT ENTITLEMENT AIN’T BANKRUPT? ERRR NOT ANY AGAIN!
WHUT’S THE CHANCE THE ABOVE IS WRONG? NONE! THE PERCENTAGES MAY VARY, BUT WITH INFLATION (READ PAYCUTS) WITH NOBODY IMMUNE… WOW I LOVE EQUALITY!
WHAT A RELIEFE WHEN OUR FUTURE IS SO 1000% PREDICTABLE! PLEASE I’M ON FOOD STAMPS, DON’T STEP ON MY AIR HOSE,THANK YOU VERY MUCH… GASP GASP GASP, RIOTS IN CALIFORNEE- I- AYYY? NAH JESS A LOCAL S – – T STORM, IT WILL PASS… ERRR LIKE A PLAGUE INFECTING FROM SCHOOL TO SCHOOL, CITY TO CITY STATE TO STATE..
HOW DO YAH SPELL JUGGERNAUT? SHIP OF STATE DOOMED… BLEEP BLEEP BLEEP MAY DAY MAY DAY MAY DAY! BLUB BLUB BLUB…. WHUT’S THE MORSE FOR S-O-S DEE DAHH DEE OR DAHH DEE DAHH? NOT TO WORRY… JESS MESSIN’ WITCH YER HAID :o)
hooooo-kay, excellent advice, excuse me, I have a call coming in a minute.
Your time isn’t going to waste with your article. a lot of thanks and go with posting You’ll absolutely reach your ambitons! have a superb day!
I agree, a lot of thanks to the author. for taking the time to share this, awesome site.
Hey Bob! Anyway to block the “Website” part of “Leave a Reply”? It attracts too many flies.
I do not entirely agree with the 1st responder. His answer has some validity but not complete validity. Trading options will not wipe you out, only the money invested in them. They generally are not leveraged. A good candidate might be VLO. It certainly matches several of your criteria. Based on just about every criteria imaginable, it is undervalued. What could be more favored than oil right now Another might be ABX. If the Fed cuts the interest rate, the dollar will not be worth wiping your bottom with.
The problem is that the stock market doesn’t sell shares. It sells promises of shares. Transferring shares is too slow, so the system created the idea that the shares stay in one place, registered to a depository and what is bought and sold is claims on shares at the depository.
Bernie Madoff (really), one of the founders of the Nasdaq, introduced the “Madoff Exemption” that was approved by the SEC and which allows IOU’s instead of real shares to trade on the market.
The result of this is that stocks can go down just because the specialist / market maker / short hedge fund will lose money if they go up. They are able to introduce an infinite number of new IOU’s into the market to overwhelm demand and force a lower price, merely by putting up collateral. It can be a sucker’s game for the little guy.
When an ETF moves up or down, this disconnect between the company’s value and the motives of the people that actually set the price outside of supply and demand means that Cringely’s strategy could be ineffective.
Check:
https://www.deepcapture.com – an activist group – to understand this.
The result of this is that stocks can go down just because the specialist / market maker / short hedge fund will lose money if they go up. They are able to introduce an infinite number of new IOU’s into the market to overwhelm demand and force a lower price, merely by putting up collateral. It can be a sucker’s game for the little guy.
The recent roundup of hedgies and their enablers has led to the re-reporting of the salient fact: the individual investor is convinced (rightly so, it seems) that Wall Street is a rigged game. I expect that this will lead to further withdrawals of funds, and a drop in the market. Buy short ETF’s.
Banter aside we all knew it wasn’t going to be easy, early days yet. I hope the Eng bowlers were paying attention to the length that Siddle bowled, superb spell. To be honest, it’s hard to be overly critical of England. Losing the captain on the third ball of an ashes series created serious pressure. Then pulling back to a reasonable position a hattrick turns the inns on its head. Thatt’s cricket for you, one man can do that and a hatttrick will do that. Just as well for the Aussies for Hilfenhaus and Johnson looked Ordinary. Most of those wickets fell to good balls, only a couple injudicious shots. That said we’re likely to end up on the back foot, just a question of how many. It was a fascinating day, let’s hope we have a better one tomorrow.
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Blogging like you do is such an art and you obviously have that skill here – I don’t but I did find this that made me smile so maybe I can return the favour by making you smile too?
Who is General Failure and why is he reading my hard disk? 🙂
The markets already have this worked out. It’s called rebalancing arbitrage. There is a very small window of opportunity to make the trades. And you’ll need extremely good execution. Your etrade account isn’t going to do it for you.
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one man can do that and a hatttrick will do that. Just as well for the Aussies for Hilfenhaus
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