Thursday, September 11, 2014

What If the Easy Money Is Now on the Bear Side?

Complacent melt-ups aren't just boring--they're not very profitable.

File this under Devil's Advocate: what if the easy money in the stock market is no longer the "guaranteed" Bull melt-up but the Bearish bet on a sudden air pocket?Just as a thought experiment, put yourself in the shoes of the money managers who have the leverage to move the markets.

You probably know the drill: program your trading bots to recognize every technical trading scheme's key support and resistance levels, and then unleash huge futures/options buys after hours or pre-open so the market jumps in the direction that makes you the most money.

Unleashing a tsunami of buy orders forces Bears to cover their bets on a decline (shorts), goosing the market higher. The melt-up depends not just on trading bots hammering the market in the desired direction with massive buy orders--it depends on a supply of nervous Bears to cover their shorts by buying stocks. This buying triggers others' trading bots to buy into the rally.

Short-covering is an essential source of the self-reinforcing buying that has kept the U.S. market melting up for years without any gyrations down of more than a few percentage points.

Buy the dips has entered the Pavlovian realm of automatic response because the managed tsunamis of futures/options force those betting on a decline to cover their shorts by buying, pumping the rally up with steroid-like buying.

The problem with this guaranteed melt-up is the unceasing advance and immediate buy the dip response has decimated the ranks of Bears willing to bet against the melt-up. This has removed one of the primary fuel sources of the melt-up.

In other words, the managers' great success with forcing Bears to seek cover has drained a key reservoir of buying power. Eradicating the Bears has all been jolly good sport, but it has also reduced the shorts who can be forced to cover, which means the market is left with only the managers' manipulations and the other institutional trading bots that follow trends.

Consider this chart of the Rydex ratio of Bear/Bull assets, from John Hampson:

If Market Bears were tallied, they'd be on the list of Endangered Species. There is some confusion about the true number of Bears left, as prudent money managers may buy puts (bets on a market decline) to hedge their portfolios. As a result, a mass of put buying may reflect hedging, not Bearish bets.

The net result of eradicating the Bears is the gains from the melt-up are now limited. If you're a serious manager of serious money, squeezing out a couple of points from the melt-up is not only boring--it's detrimental to your career, because you need to beat the index melt-up to keep your big-bucks job and skim your payoff.

Which leads to the notion that the really big money waiting to be skimmed from the unwary is not more melt-up but a sudden "unexpected" meltdown that catches everyone who isn't short off-guard. The most profitable trade would be to stealthily build a short position while telling everyone else how the melt-up was guaranteed essentially forever ("the Fed, ECB and Bank of Japan have your back," etc.).

To make sure nobody strayed from the long side of the boat, you'd unleash the usual frenzy of buy orders at every dip, because the last thing you'd want is to give anyone else an easy entry to the Bearish short side.

The ideal situation is a boat heavily tilted to one side with complacent Bulls confident in the continuation of the never-ending melt-up, and only yourself and a few insider cronies on the short side.

Then, when all the Bulls are happily swapping stories about how the yen carry trade guarantees capital flows into U.S. equities and other Bull stories--

BANG! You unleash a tsunami of sell orders that triggers all the trend-following trading bots to sell. When the buy the dip crowd confidently enters their buy orders, you crush them with a load of futures and options orders that reverse the uptick. This triggers another wave of bot selling.

Since there are no Bears left except you and your cronies, the buy the dip retraces have no legs: they quickly peter out because no Bears are left to spark short-covering buying.

Since there are no Bears left, there's only the trading bots programmed to follow trends: and with your leverage and bag of tricks, that trend can go down faster than complacent Bulls thought possible.

Then, when the Bulls are stampeding in panic selling, you cover your Bear bets and start buying from the panic-stricken Bulls. The Hobby Bears who went short near the bottom are forced to cover as your buying turns the tide, and the market is soon in full recovery mode.

This is such an obvious (and immensely profitable) play, I'm surprised we haven't seen it more often. Complacent melt-ups aren't just boring--they're not very profitable.

Get a Job, Build a Real Career and Defy a Bewildering Economy(Kindle, $9.95)(print, $20)
go to Kindle editionAre you like me? Ever since my first summer job decades ago, I've been chasing financial security. Not win-the-lottery, Bill Gates riches (although it would be nice!), but simply a feeling of financial control. I want my financial worries to if not disappear at least be manageable and comprehensible.

And like most of you, the way I've moved toward my goal has always hinged not just on having a job but a career.

You don't have to be a financial blogger to know that "having a job" and "having a career" do not mean the same thing today as they did when I first started swinging a hammer for a paycheck.

Even the basic concept "getting a job" has changed so radically that jobs--getting and keeping them, and the perceived lack of them--is the number one financial topic among friends, family and for that matter, complete strangers.

So I sat down and wrote this book: Get a Job, Build a Real Career and Defy a Bewildering Economy.

It details everything I've verified about employment and the economy, and lays out an action plan to get you employed.

I am proud of this book. It is the culmination of both my practical work experiences and my financial analysis, and it is a useful, practical, and clarifying read.

Test drive the first section and see for yourself.     Kindle, $9.95     print, $20

"I want to thank you for creating your book Get a Job, Build a Real Career and Defy a Bewildering Economy. It is rare to find a person with a mind like yours, who can take a holistic systems view of things without being captured by specific perspectives or agendas. Your contribution to humanity is much appreciated."
Laura Y.

Gordon Long and I discuss The New Nature of Work: Jobs, Occupations & Careers(25 minutes, YouTube) 

NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Ryan R. ($100), for your outrageously generous contribution of handmade jewelry to this site -- I am greatly honored by your artistry and steadfast support and readership.Thank you, Creig F. ($5/month), for your exceedingly generous re-subscription to this site -- I am greatly honored by your steadfast support and readership.

Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.

Our Privacy Policy:

Correspondents' email is strictly confidential. This site does not collect digital data from visitors or distribute cookies. Advertisements served by third-party advertising networks such as Adsense and Investing Channel may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative)
If you have other privacy concerns relating to advertisements, please contact advertisers directly. Websites and blog links on the site's blog roll are posted at my discretion.

Our Commission Policy:

As an Amazon Associate I earn from qualifying purchases. I also earn a commission on purchases of precious metals via BullionVault. I receive no fees or compensation for any other non-advertising links or content posted
on my site.

  © Blogger templates Newspaper III by 2008

Back to TOP