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Why I Avoid Using Stop-Loss Orders

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I haven’t been posting here for a while because I have been busy writing about the stock market at the Wall Street Sector Selector website.

Within three months after I first started this blog, I began criticizing the permissive attitude taken by the Securities and Exchange Commission toward predatory securities trading tactics.

Since that time absolutely nothing has changed.  In fact, the SEC has allowed the stock market to become an even more dangerous place for “retail investors” (mom and pop) to keep their life savings.

The use of “limit orders” has become a joke.  The only reason for using a limit order is to let your enemies (the predatory traders) know the maximum extent to which you will allow yourself to be screwed on a trade.  Since July of 2009, I have discussed the threat posed to retail investors by the use of High-Frequency Trading (HFT) systems.  Computers – programmed with predatory algorithms – can engage in “computerized front-running” through the use of “flash orders” to force your own limit order to be executed at its most extreme expense to you.  I discussed this situation in more detail on May 18, 2010.

I rarely use “stop loss” orders.  They are used by investors to limit their loss if a stock price sinks.  The investor specifies a stop price (based on a percentage of the purchase price which is the maximum amount the investor is willing to lose on the stock).  If the stock eventually drops to the price in the stop order, the transaction is initiated and the order goes out to the exchange as a market order – to be filled at the best available price at the time.  In other words, there is no guarantee that the order will be filled at the price specified in the stop order.  In the “flash crash” on May 6 of 2010, many investors lost their shirts because their stop orders were executed and by the time the investors tried to repurchase the stocks, the prices rebounded to where they were before the flash crash.  Worse yet, by the time their stop orders were actually filled, the stock prices had dropped tremendously.  Not only did those investors lose money on the stop orders for no good reason – but many chose to buy back their stocks at the pre-crash prices.  As a result, they lost twice as much money just because of an emotional attachment to the stock.  (Emotional attachment to a particular stock is a bad investment habit.)  Since that time, a number of “mini flash crashes” have been engineered by predatory traders on particular stocks, forcing investors off their positions to take losses, which ultimately benefit the predators, who use stealthy tactics to reap those profits without being caught.

Maureen Farrell recently wrote an interesting piece for CNNMoney about the consequences of  “mini flash crashes”.  Here is some of what she had to say:

Stock exchanges have explicit rules for canceling “clearly erroneous trades” and for triggering so-called circuit breakers that halt trading.  None of the trades mentioned in this story met that criteria.

Generally, trades can be canceled if they fall 5% to 10% from the last trade, but the rules vary, depending on the market cap of a company and its trading volume.

Investors still have to notify the exchange within 30 minutes if they want their trade to be canceled.

And because many of the wild swings aren’t extreme enough to be considered “clearly erroneous,” individual investors may not even be aware that certain trades are being executed.

Although the article noted that “(t)he SEC continues to make changes to try to combat the frequency and impact of the mini flash crashes”, there is apparently nothing being done by the SEC to prevent the predatory engineering of those crashes.  The SEC is apparently doing nothing to allow investors to unwind trades triggered by those crashes.  More important, the SEC is doing nothing to track down and prosecute the culprits responsible for engineering and profiteering from these events.

Wall Street needs a new Sheriff.


 

The Employment Outlook Debate

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March 10. 2010

The February non-farm payrolls report from the Bureau of Labor Statistics boosted the optimism of many commentators who follow the unemployment crisis.  Nevertheless, predictions about the employment outlook for the remainder of 2010 are extremely conflicting.  Surfing around the web will give you completely divergent prognostications, usually depending on the locale.  Here are some examples:  Los Angeles job outlook expected to improve (Los Angeles Times); Atlanta employers expect to hold payrolls steady — neither hiring nor firing (Atlanta Journal-Constitution) Boston employers expected to add jobs (The Boston Globe — quoting a Manpower report); Employers still skittish on hiring (CNNMoney.com); Columbus hiring prospects for upcoming quarter weaken slightly (ledger-inquirer.com).

In an essay for the istockanalyst.com website, Ockham Research began by pointing out that 8.4 million jobs have been lost since the recession began in December of 2007.  The fact that the S&P 500 has advanced 70% during this time has encouraged pundits to believe in a jobless recovery.  After noting Senator Harry Reid’s odd reaction to the February non-farm payrolls report:  “Only 36,000 people lost their jobs today, which is really good” — the piece continued:

After that blunder, the report on Bloomberg.com struck us in just how optimistic it is towards March’s employment data, thanks in part to temporary hiring for census workers which could add more than 100,000 jobs this month.  However, a strategist for Goldman Sachs (GS) estimated 275,000 job gains; another economist predicted “easily” reaching 300,000.  Chief  US economist at Deutsche Bank (DB) took the prize though, saying that a gain of 450,000 “can’t be ruled out.”

The Ockham Research piece again emphasized that many of the optimistic views are based on the addition of census workers to the rolls of the employed, despite the fact that these are temporary positions, eventually disappearing in mid-summer.  Ockham Research was also dismissive of the inclusion of workers added to payrolls simply because of summertime seasonal employment opportunities.  They concluded on this note:

Of course, no one can predict the future and predictions about macroeconomic data points are extremely thorny.  As much as we would like to believe they are correct and job growth will return in robust fashion, we are a bit skeptical.  They have raised the bar for expectations, so it will be extremely interesting to see the market’s reaction when the data comes in.

The Seeking Alpha website featured a posting by David Goldman which began with these remarks:

.  .  .  it would be hard to envision significant declines in payroll employment from already miserable levels.  But the sort of things that generate jobs — venture capital investments, small business expansion, and so forth — are as dead as the Monty Python parrot.

Mr. Goldman focused on the February Small Business Confidence report by Discover Card, which revealed that America’s small business owners remained cautious about the economy during February as they expected economic conditions to stay largely the same during the coming months.  At the close of the piece, we are reminded of its title, “Where Will the Jobs Come From?”   —

With the continuing catastrophe in both the residential and commercial real estate markets, small business capital has imploded.  And small business surely isn’t getting help from the banking system, where loans still are contracting at the fastest pace on record.

Two economists for the Federal Reserve Bank of San Francisco, Mary Daly and Bart Hobijn, recently published a research paper addressing the surprisingly high unemployment rate for 2009, based on a principle known as Okun’s Law.  They explained it this way:

Okun’s law tells us that, for every 2% that real GDP falls below its trend, we will see a 1% increase in the unemployment rate.  Since real GDP was almost flat in 2009 while its trend level increased by 3%, the unemployment rate under Okun’s law should have increased by 1.5 percentage points.  Instead it rose by 3 percentage points, more than twice the predicted increase.

I will now fast-forward to their conclusion:

The data presented here consistently point to unusually strong productivity growth as the main driver of the departure from Okun’s law in 2009.  A key question that remains unanswered by this analysis is whether this pattern will continue in 2010.  Most forecasters assume that the economy will return to its historical path this year, following Okun’s two-to-one ratio of changes in GDP and changes in unemployment.  Under this scenario, unemployment would begin to edge down this year as the economy recovers and gains momentum.  But there are clearly risks to this view.            .  .   .

Anecdotal evidence suggests that efforts to contain costs and remain nimble in the face of uncertainty have become a fixture in business strategy.  If productivity keeps on growing at an above-average pace, then unemployment forecasts based on Okun’s law could continue to be overly optimistic.

So there you have it.  Pick your favorite prediction and run with it.  The Manpower Employment Outlook Survey seems to have a reasonable take on expectations for the second quarter of 2010:

“U.S. hiring activity is still in neutral, but revving toward first gear,” said Jonas Prising, Manpower president of the Americas.  “It’s moving in the right direction, but it will take some time, with no major speed bumps, before it can accelerate.”

Let’s just hope the road ahead doesn’t have any sinkholes.



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An Ominous Drumbeat Gets Louder

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August 13, 2009

Regular readers of this blog (all four of them) know that I have been very skeptical about the current “bear market rally” in the stock markets.  Nevertheless, the rally has continued.  However, we are now beginning to hear opinions from experts claiming that not only is this rally about to end — we could be headed for some real trouble.

Some commentators are currently discussing “The September Effect” and looking at how the stock market indices usually drop during the month of September.  Brett Arends gave us a detailed history of the September Effect in Tuesday’s edition of The Wall Street Journal.

Throughout the summer rally, a number of analysts focused on the question of how this rally could be taken seriously with such thin trading volume.  When the indices dropped on Monday, many blamed the decline on the fact that it was the lowest volume day for 2009.  However, take a look at Kate Gibson’s discussion of this situation for MarketWatch:

One market technician believes trading volume in recent days on the S&P 500 is a sign that the broad market gauge will test last month’s lows, then likely fall under its March low either next month or in October.

The decline in volume started on Friday and suggests the S&P 500 will make a new low beneath its July 8 bottom of 869.32, probably next week, on the way to a test in September or October of its March 6 intraday low of 666.79, said Tony Cherniawski, chief investment officer at Practical Investor, a financial advisory firm.

“In a normal breakout, you get rising volume. In this case, we had rising volume for a while; then it really dropped off last week,” said Cherniawski, who ascribes the recent rise in equities to “a huge short-covering rally.”

The S&P has rallied more than 50 percent from its March lows, briefly slipping in late June and early July.

Friday’s rise on the S&P 500 to a new yearly high was not echoed on the Nasdaq Composite Index, bringing more fodder to the bearish side, Cherniawski said.

“Whenever you have tops not confirmed by another major index, that’s another sign something fishy is going on,” he said.

What impressed me about Mr. Cherniawski’s statement is that, unlike most prognosticators, he gave us a specific time frame of “next week” to observe a 137-point drop in the S&P 500 index, leading to a further decline “in September or October” to the Hadean low of 666.

At CNNMoney.com, the question was raised as to whether the stock market had become the latest bubble created by the Federal Reserve:

The Federal Reserve has spent the past year cleaning up after a housing bubble it helped create.  But along the way it may have pumped up another bubble, this time in stocks.

*   *   *

But while most people take the rise in stocks as a hopeful sign for the economy, some see evidence that the Fed has been financing a speculative mania that could end in another damaging rout.

One important event that gave everyone a really good scare took place on Tuesday’s Morning Joe program on MSNBC.  Elizabeth Warren, Chair of the Congressional Oversight Panel (responsible for scrutiny of the TARP bailout program) discussed the fact that the “toxic assets” which had been the focus of last fall’s financial crisis, were still on the books of the banks.  Worse yet, “Turbo” Tim Geithner’s PPIP (Public-Private Investment Program) designed to relieve the banks of those toxins, has now morphed into something that will help only the “big” banks (Goldman Sachs, J.P. Morgan, et al.) holding “securitized” mortgages.  The banks not considered “too big to fail”, holding non-securitized “whole” loans, will now be left to twist in the wind on Geithner’s watch.  The complete interview can be seen here.  This disclosure resulted in some criticism of the Obama administration, coming from sources usually supportive of the current administration. Here’s what The Huffington Post had to say:

Warren, who’s been leading the call of late to reconcile the shoddy assets weighing down the bank sector, warned of a looming commercial mortgage crisis.  And even though Wall Street has steadied itself in recent weeks, smaller banks will likely need more aid, Warren said.

Roughly half of the $700 billion bailout, Warren added, was “don’t ask, don’t tell money. We didn’t ask how they were going to spend it, and they didn’t tell how they were going to spend it.”

She also took a passing shot at Tim Geithner – at one point, comparing Geithner’s handling of the bailout money to a certain style of casino gambling.  Geithner, she said, was throwing smaller portions of bailout money at several economic pressure points.

“He’s doing the sort of $2 bets all over the table in Vegas,” Warren joked.

David Corn, a usually supportive member of the White House press corps, reacted with indignation over Warren’s disclosures in an article entitled:  “An Economic Time Bomb Being Mishandled by the Obama Administration?”  He pulled no punches:

What’s happened is that accounting changes have made it easier for banks to contend with these assets. But this bad stuff hasn’t gone anywhere.  It’s literally been papered over. And it still has the potential to wreak havoc.  As the report puts it:

If the economy worsens, especially if unemployment remains elevated or if the commercial real estate market collapses, then defaults will rise and the troubled assets will continue to deteriorate in value.  Banks will incur further losses on their troubled assets.  The financial system will remain vulnerable to the crisis conditions that TARP was meant to fix.

*   *   *

In a conference call with a few reporters (myself included), Elizabeth Warren, the Harvard professor heading the Congressional Oversight Panel, noted that the biggest toxic assets threat to the economy could come not from the behemoth banks but from the “just below big” banks.  These institutions have not been the focus of Treasury efforts because their troubled assets are generally “whole loans” (that is, regular loans), not mortgage securities, and these less-than-big banks have been stuck with a lot of the commercial real estate loans likely to default in the next year or two.  Given that the smaller institutions are disproportionately responsible for providing credit to small businesses, Warren said, “if they are at risk, that has implications for the stability of the entire banking system and for economic recovery.”  Recalling that toxic assets were once the raison d’etre of TARP, she added, “Toxic assets posed a very real threat to our economy and have not yet been resolved.”

Yes, you’ve heard about various government efforts to deal with this mess.  With much hype, Secretary Timothy Geithner in March unveiled a private-public plan to buy up this financial waste.  But the program has hardly taken off, and it has ignored a big chunk of the problem (those”whole loans”).

*   *   *

The Congressional Oversight Panel warned that “troubled assets remain a substantial danger” and that this junk–which cannot be adequately valued–“can again become the trigger for instability.”  Warren’s panel does propose several steps the Treasury Department can take to reduce the risks.  But it’s frightening that Treasury needs to be prodded by Warren and her colleagues, who characterized troubled assets as “the most serious risk to the American financial system.”

On Wednesday morning’s CNBC program, Squawk Box, Nassim Taleb (author of the book, Black Swan — thus earning that moniker as his nickname) had plenty of harsh criticism for the way the financial and economic situations have been mishandled.  You can see the interview with him and Nouriel Roubini here, along with CNBC’s discussion of his criticisms:

“It is a matter of risk and responsibility, and I think the risks that were there before, these problems are still there,” he said. “We still have a very high level of debt, we still have leadership that’s literally incompetent …”

“They did not see the problem, they don’t look at the core of problem.  There’s an elephant in the room and they did not identify it.”

Pointing his finger directly at Fed Reserve Chairman Ben Bernanke and President Obama, Taleb said policymakers need to begin converting debt into equity but instead are continuing the programs that created the financial crisis.

“I don’t think that structural changes have been addressed,” he said.  “It doesn’t look like they’re fully aware of the problem, or they’re overlooking it because they don’t want to take hard medicine.”

With Bernanke’s term running out, Taleb said Obama would be making a mistake by reappointing the Fed chairman.

Just in case you aren’t scared yet, I’d like to direct your attention to Aaron Task’s interview with stock market prognosticator, Robert Prechter, on Aaron’s Tech Ticker internet TV show, which can be seen at the Yahoo Finance site.  Here’s how some of Prechter’s discussion was summarized:

“The big question is whether the rally is over,” Prechter says, suggesting “countertrend moves can be tricky” to predict.  But the veteran market watcher is “quite sure the next wave down is going to be larger than what we’ve already experienced,” and take major averages well below their March 2009 lows.

“Well below” the Hadean low of 666?  Now that’s really scary!