Back in 2009 I wrote a story about some odd occurrences in the market. Anyone who keeps a pretty close eye on the market can remember the period during QE1 (see here for the correlation between POMO and equities). After the summer rally of 2009 volume fell off a cliff. But the rally powered higher. And much of it came from enormous institutional trades that were placed during quiet periods of the trading day. It was not unusual to see the futures surge 0.25% on no news on randomly huge volume. Now, this might not seem unusual to the casual reader, but the orders were odd in that there was an unusual sense of urgency from these institutions. They were not just placing orders. They were placing orders beyond the ask price in what appeared like an intentional attempt to move the market rather than obtain the best price.
We haven’t seen that so much during the trading day during QE2, however, it has been more than noticeable in the overnight sessions. Anyone who trades S&P futures overnight has noticed this. I’ve talked to several hedge fund managers and other futures traders, none of whom can explain this phenomenon, but all of whom witness it. Here’s how it works:
As you likely know, orders are always placed at the bid and ask. Bids are generally buys while asks are generally sells. But you can hit the bid or lift the ask price if desired. For instance, in a panicky market you will often see the bids hit and the market flushed (this is all that happened during the flash crash). This means there is literally not enough liquidity on the buy side to handle the volume of selling and the panic selling slams the market price lower. This is generally why stocks decline faster than they rise. Fear is a powerful motivator. This is particularly noticeable if you trade illiquid markets where the spreads are wide. While the S&P futures are by no means illiquid the overnight market is certainly less liquid than the daytime session.
What has been happening in recent months is obvious. Institutional buyers are entering large buy orders BEYOND the asking price. What does this mean? It means we might have a specific number of orders on the ask side and if you enter an order that is larger than all of these sell orders you can essentially slice through the market like a hot knife through butter. Imagine a mounted 50 cal at the Battle of Gettysburg with a line of US soldiers walking towards you in formation. You get the picture. You just knock out all the orders like dominoes falling. You can see this in last night’s session (shown below). You can’t see all of the orders perfectly because the two largest orders skew the data, but if you watch in real-time it’s apparent that buyers are coming into the market and taking out the ask side of the order book. Look at the price surge in tandem with volume increases:
I don’t know if this is sheer stupidity, an eagerness to get into equities, some sort of malfeasance or what, but I know it’s odd. And I know that many other savvy and experienced traders see it routinely these days and simply can’t explain it (although most have their theories). You might not think it’s bizarre, but I can’t imagine, for the life of me, why you would enter an order at the ask price for 7,000 ES contracts at a price that is 3 handles higher than the current price. There is simply no explanation.
The futures market is quiet enough that the market doesn’t “run away” from you. Getting a fair price in the overnight session is never really a concern. There is no news. The market is generally quiet. Volume is pretty low. It’s not like entering a bid for Apple at $358 and having it run away from you to $359 in 10 minutes. That just isn’t a huge concern in the futures (until now). I like to think I’m generally levelheaded, but I’ve been around long enough to know when I see something unusual….This is either insider trading (knowing claims, productivity data and ISM will all beat on the upside), incredible trading ignorance (unlikely) or malfeasance. Take your pick.
The main takeaway is that there is a distinct trend in the market following these events. Last night I was emailing a friend in Asia who works at a big bank. With the S&P futures up just 5 points at 3AM EST (on no news) I told him – “this market is going to rip the heads off of shorts tomorrow. I guarantee it.” A few minutes later I wrote on Twitter: “I will be shocked if we are not up big tomorrow”. The action is transparent. When these buyers are in the overnight market the equity markets surge the next day and the action is always consistent. The market will stay pinned at its daily highs as if to be sitting on Atlas’s shoulders – just propped up perfectly and guaranteed to close at the highs of the day. I don’t know if this has to do with QE2 (there is no operational explanation for that) or what, but it is plain as day to anyone who takes the time to actually watch this unusual trading action. Someone bigger than the rest of us wants this market higher and they’re doing it while most of us sleep…Perhaps I am making something out of nothing, but it just doesn’t add up if you ask me.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.