Trading New Market Realities

Part Two

This is the subject that was first announced at a financial expo in Kiev (then in Moscow) in a report entitled 'Highly Effective Investments: Trading New Market Realities'.

Many wanted to attend these events, but only a few could afford to. This is why it was decided to create a series of articles based on Part One (a short video presentation called SNIPING - NEW TRADING TECHNOLOGIES - can be viewed for practical methods).

It was said in the previous issue that conditions of market trading have changed over the past couple of years to a degree that many successful traders and an entire army of funds and other market players got 'kicked out' of the market. The reason was that market mechanisms, irrelevant until that time, were triggered rather than some people were more stupid and sluggish than others.

What happened, after all?

The answer is simple and many know it without, however, trying to see deeper - robots and a whole new army of small speculators have come to the stock market. It was they that so quickly changed all the rules of the game that it took the stock market decades to establish.

Let's have a closer look as this might be nonsense not worth our attention? I suggest we look at a few reasons why it became harder for us to trade and how this can be overcome...

A lot of traders believe high volatility in the market offers a good chance to make money. This is the case but, usually, not for them.

An illustration: S&P futures before and after the July 2011 market slump:



With an average range of 10-20 dollars per session, volatility goes hugely overboard during a time of instability (58.23 in the chart). This is the most dangerous time in the market:

 

Overall, volatility can be viewed as how fast the market changes. This is kind of an indicator of instability and unpredictability. Interestingly, this volatility has only been growing in recent years despite all measures taken by stock markets to boost liquidity. Usually, it is low-liquidity markets that the highest volatility is typical of because they do not have so many buyers and seller. This is where the price readily reacts to large orders. Still, it also grows for the most liquid and popular instruments.

Take one week - a couple of months after the July events:



One situation is witnessed for a third day in a row during this highly volatile week (second week of September 2011). There is a significant fall in the morning followed by aggressive buying and growth. Volatility is still overboard...

This growing volatility of all markets means they are radically changing.

This is why so many traders and financial institutions that used to steadily generate profits fell after 2008. Now, many of them write books or operate stock exchange services because they simply failed to see and understand reasons behind these new tendencies that ousted them from the market.

Let's look at some reasons of such drastic changes and try to figure out how one can work in new realities.
The first thing one needs to take into account is that the market membership has changed qualitatively. Only an insignificant part of the population used to trade in stock markets, but now a huge number of players get involved not only from developed, but also from developing countries (including the post-soviet space). As a result, market trading has changed both in terms of quantity and quality. Have a look at the diagram:



It is clear from the diagram borrowed from the official website of the World Federation of Exchanges that the number of trades in a stock exchange has been inevitably growing over the past decade showing a growth of about 700% in the past 10 years (from 2 to 15 billion a year) though the average trade size has fallen 85% in the decade (from USD 50,000 to 10,000). This means the rules of the game have changed and now speculative sentiment intended to make profits through short-term trades increasingly prevails in the exchange as compared to genuine investments as it used to be.

It was mainly investors that used to trade in NYSE (the average trade being one order of magnitude higher than in speculative NASDAQ, which kept volatility down. But the arrival of robots and short-term speculators simply got it all mixed up).

The next issue will deal with main reasons behind this and other processes in the modern market. Well, to keep trading successful in the modern market, we had to introduce our own techniques that are now part of the SNIPING method.

Igor Vasev, Head of the Futures Trading and Stock Exchange Faculty