May 11, 2010
Computer Glitch or Exquisite Strategy
The sole cause of the Thursday May 6th 1000 pt drop in the Dow may have been Large Volume Traders coupled with the confluence of three regulatory shortcomings: The absence of the "Uptick Rule", "Naked Shorts", and "High Frequency Trading". Computers only did what they were programmed to do.
Consider the following: A market growing more nervous and anxious by the day due to an "Overdue" 14% - 20% Correction and potentially most serious financial crisis looming in Europe with an apparent paucity of concern on the part of the ECB. The real possibility that if Greece (the Euro) were to collapse - contagion could spread the crisis globally. What are smart traders to do to profit from the crisis atmosphere (China with several trillion US assets, Iran on other enemy of the US, Hedge Funds).
1. Place massive GTC orders for 50-200 quality stocks in tranches priced say - 15%, 30%, and 45% below the 50d moving average price of each respectively.
2. Sit back and wait for a critical test (i.e. Germany to approve/reject the Greek Bailout, ECB to step up/stand down, etc.).
3. When the panic selling begins in earnest (perhaps primed with a few selected moderately large shorts) - Throw in massive Naked" shorts to equal the sum of the GTC orders.
4. Wait for the real panic to begin and to be "stopped in" by the GTC orders, or in the alternative to cover the shorts at a nice profit when the panic selling abates.
5. Plan ahead for a replay when the Euro Zone spreads to Spain, Portugal, Italy, Ireland, France??, or Britain.
For the sake of the small investors, 401Ks, Pension Funds, etc. all three of the facilitators: Naked Shorts, absence of an Uptick Rule, and High Frequency Trading must be made illegal or strongly regulated (with jail time penalties). Speed Bumps although helpful in normal swoons might only add to the downward pressure if such "malignant" naked shorts were in line but not being executed.
A trader (perpetrator) might just be able to mask his tracks to a degree by shorting the ETFs and letting them prime the pump (so to speak) and do the heavy heavy lifting (heavy short selling to get the panic rolling), only adding his own shorts to ensure that there is enough "Gasoline on the Fire".