Hedge funds make it by hook or by crook

Hedge funds make it by hook or by crook

When I first heard of the Flash Crash early Friday morning. my first thought was that the robo traders were at it again.  I checked the price/time chart and quickly discovered that the plunge got started right as the Asian markets opened at 12 midnight UK time.  That timing was very suspicious because trading volumes are normally very thin at that time.  Even small orders would move the market.

But the immense collapse at midnight must have been made on sell order(s) that were orders of magnitude larger than normal.

Here is the 10-min chart showing the extreme moves in a very short space of time

Within the first ten minutes of Asian trading, the market fell from 1.26 to a low of 1.18 (although on Friday, the low print was shown as 1.12) and then rallied to 1.2050.  And in the following 10 minutes, the market rallied to 1.24 and settled at 1.23 area.

Incidentally, I am not surprised by the confusion as to Friday’s low trade – in a very fast market, some trades get missed and some cancelled.  The CME is obliged to post the highs and lows of the day accurately. I will live with the 1.18 low.

The question is: Why would any robo trader decide to sell such huge volume at that time?  If a trader has a large long position they wish to sell, they normally scale the sale in chunks over time so as not to disturb the market too much – and certainly do not do it in thin trading conditions.  So that was not the reason.

I believe a large operator(s) decided to bear raid the market when it was at its most vulnerable at midnight UK time.  The large sell orders set off large numbers of sell-stops and that augmented the decline into a cascade.  They then could buy back (cover) their shorts at much lower prices in tranches to bag a very fast profit.

In fact, this was the prefect bear raid on a currency.  Already, sentiment towards cable was plunging and talk was rife of a hard Brexit-induced collapse as sterling was already ‘overvalued’ at 1.30.  The shorts were pushing on an open door.

But why now?  Why did the robo traders decide that Friday was the perfect time to pounce? I have a hunch these systems incorporate sentiment readings – perhaps using social media references to certain words – and it was that that set them off automatically while the operators were alseep!

One other factor that I believe was in play. That was that hedge funds were massively long gold and silver as they crashed through support on 4 October.  That must have put a dent in fourth quarter performance – and right at its start!  They needed to make up these losses – and fast.  And what a cunning way to do it – by crashing sterling.  That was the most vulnerable large market available to them.

One other measure of vulnerability is to be gleaned from the COT data – here is the latest as of October 4

Hedgies are correctly 3:1 short while the small spec is about evens.  The commercials are 2:1 long.  But the small spec holding of 30k longs (over one half of the hedge funds’ long position) is the most vulnerable because it is the small specs who usually trade with protective stops.  These will have been placed all the way down from the 1.26 level on Thursday.  And it was these sell stops that helped fuel the collapse like a Chinese firecracker.  It was the dry tinder on the market floor.

That is how some hedge funds manipulate the markets.  In fact, they use the very same dodgy practices (but with modern technology, of course) that Jesse Livermore used in the 1920s as described in the classic Reminiscences of a Stock Operator authored under his pseudonym Edwin Lefevre.

I heartily recommend reading that tome – and I do so at least once a year.  It seems the robo traders have been using it as an instruction manual.



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