Think You Can Outrun a Global Flash Crash?

It was while under the influence of LSD that a childhood friend of ours decided to end a promising career as a commodity trader.  He was buying and selling pork belly contracts at the time but dropped acid one day hoping to gain valuable insights into the markets — insights that presumably lay beyond the grasp of rational thinking.  Chuck had insights all right, but not the kind he’d expected.  Instead of having potentially profitable spreads, combos, strips and straddles leap out at him from his trading monitor, his febrile mind was overwhelmed by images of the slaughterhouse — of 400-pound sows dripping blood from a conveyor belt. The experience was cathartic enough that his next job, announcing professional basketball games, was as far from the feedlots and butcheries as he could get.

We mention this because market-watching has become all-too-abstracted for us lately as well. Ponder the whys and wherefores of the stock market for too long and you begin to believe that investors are being led, one rally at a time, to the slaughterhouse.  Or so it would seem. Europe’s bailout, for one, is a hoax that can only end badly for us all. And the torrent of lies that have kept the U.S. out of statistical recession are so egregious that a bust of 1929 proportions could occur literally overnight and at any time.  As we know, the mindless herd can have epiphanies just like individuals. Except that they are called panics. And yet, stocks continue to ratchet higher most of the time, pausing only long enough to allow sector rotation and the orderly flow of money in and out of the flavor-of-the-week asset class.

We’ve Had Our Warning

Someone in the Rick’s Picks forum described this yesterday as musical chairs, and we would agree. The remark was in response to a post by a regular poster who evidently believes he’ll know when it’s time to exit the stock market. Although he had asserted that there have always been warning signs in the past, we don’t recall any such signs prior to the May 2010 Flash Crash. Some traders we know have bragged that they saw the October 1987 crash taking shape that summer, like dark cumulus clouds on the  horizon.  But did they really? We doubt it. In point of fact, crashes occur because few have noticed or heeded whatever warnings signs were there to be observed.

To those who may be looking for the next warning sign, we would say: The May 6 2010 crash was your warning. That infamous event saw the Dow Industrials plunge 1000 points, or nine percent, only to recover the entire loss minutes later. Much as we’d like to believe that someone flipped the wrong switch, a crash of that kind could have occurred only because the electronic trading network itself had gone HAL-9000 wacky. And so it is with, not just the stock market, but the entire global financial system. It has been hard-wired to panic at ten-thousand times the speed of humans. And it therefore will, eventually.

Any trader or investor who is counting on beating HAL to the exit, or on a do-over once The Powers That Be have sorted things out, richly deserves to reap the whirlwind.

***

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  • Dave Iler April 5, 2012, 2:43 am

    The time span leading up to the flash crash saw legislation before the Senate to add more oversight to the Federal Reserve’s operation.

    The flash crash was specifically created to send a message of disapproval to the Senate so they wouldn’t pass any Fed. restrictive legislation.

    Guess what? It worked perfectly.

    There was no other reason for the flash crash.

    Not suggesting that the markets are not at risk. They are. The remaining buy-and-hold sheep will be sheered at some indeterminate point in the future. These are people who are locked into pensions, IRAs, 401ks, etc., who have funds invested in the only game in town–which of course, is stocks, or so they tell keep telling me.

    Until then, we keep straightening deck chairs on the Titanic.

    Suggest market may be OK through the end of Operation Twist (June 2012). If no QE3 then, the market becomes more at risk.

    If you’re worried about another possible (probable?) flash crash, one technique is to trade futures, and only take short trades. But you may be giving yourself away if you short the market and enter a limit order to cover, 100 points lower, when the trade is instantiated.

    • Rick Ackerman April 5, 2012, 4:08 am

      The flash crash wasn’t created, Dave, it simply happened. To understand why, you’d need to have traded on an exchange floor, as I have, against a broker who is shilling for a neural network.

  • Jill April 4, 2012, 6:57 pm

    Rich, thanks for making us aware of this situation. Apparently, we can’t get to your article without a subscription. Here is an article that is accessible about the same news item.

    http://www.washingtonpost.com/politics/jpmorgan-agrees-to-pay-20m-fine-to-settle-us-charges-of-illegally-handling-lehman-funds/2012/04/04/gIQAsflCvS_story.html

  • Rich April 4, 2012, 6:16 pm

    It appears this latest market hiccup may have been JPM bogarding segregated customer funds 22 months at LEH,
    leading to BQ, and refusing to return $333 M for two weeks after ordered to do so:

    http://www.ft.com/cms/s/0/507305fc-7e60-11e1-b20a-00144feab49a.html#axzz1r5ZYNPBM

  • gary leibowitz April 4, 2012, 6:05 pm

    Rick, I have specified my risk parameter. More precisely here is my list for staying invested. I believe there will be no strong volatile day’s ahead; closing percentage on SP500 must be below 1.5 percent. Quarterly earnings projections cannot drop across most sectors. Gas prices should not surge another 10 percent, making the price no higher than 115. No external crisis like a country default. The number of new highs to new lows should never become lopsided. Volume should continue to improve showing more participation. NASDAQ has to continue to lead on the upside. These are some of my parameters.

    In other words, if my defined scenario does not hold true I get out. My current assumption is that we have a very good year with low volatility and no protracted drops. Any correction should be a slow drawn out affair. This will imply consolidation and sector changes.
    It is in fact a very stringent, tight limiting bets. Not one I would usually make. I do so because of my strong expectation for a blowout year.

    The current economic news indicates to me the surprise will be on the strength of this economy. I also believe that before this move runs its course inflation fears will resurface. The other reason for my expectation has to do with a Fibonacci theory that states another top will form in 2013.

    Just today the fed announced no need for another stimulus package. The street reacted as expected even though the economic news was on the positive side. A great test today to see if my theory holds true, that volatility should not exceed 1.5 percent on the SPX on any given day. In fact I think the recent consolidation phase, or more precisely rotation, is just about over. I am expecting, perhaps as early as next week, another nice run up. For the full year we could see a 20 to 25 percent rise from here.

    As of this writing the SPX is down 1.16 percent. If it closes down 1.5 percent or more than I exit my position. While it looks very reachable today I suspect we will rally before the closing bell. I hope to ride this year out with some very nice gains. If my theory is wrong, or I exit prematurely, that’s fine by me. I am after all a bear in bulls clothing.

    • John Jay April 4, 2012, 6:42 pm

      Gary,
      The big mystery to me is, how long can the Fed continue to buy 60% of Treasury paper being issued/rolled over? With a reductio ad absurdum, why bother with income taxes, or for that matter with people having jobs at all? Everyone can just work at a government job and drink coffee and read the paper.
      I guess as bad as we are Europe and Japan are even worse. The BP holding over $1.50 is puzzling to me.
      Great Britain has a small population, limited natural resources, and nothing much to export once the North Sea bonanza runs out. Perhaps it is all the MENA oil money looking for a place to land in case of a revolt in the desert?

    • gary leibowitz April 4, 2012, 7:31 pm

      John, I suspect bond yields will rise this year and so will participation. As you stated the other nations are in much worse shape so money should flow to us.

      As for government jobs you will have to look elsewhere. They will continue to drop as the private sector takes up the slack.

      Has anyone noticed that there is a big rotation out of commodities, including energy. I don’t expect a large drop going forward but money should be increasing into consumer staples.

      If we have a restrain on commodity prices that will be a big boost this year for stocks and the economy.

    • Rick Ackerman April 4, 2012, 8:55 pm

      I’m not buying any of this, Gary. The banking system could collapse tonight, for all we know, and there is no scientific way to avoid the carnage if you choose to remain in the game. Meanwhile, you should stop kidding yourself that your “parameters” are going to keep you high and try when a tsunami hits.

    • Mark Uzick April 4, 2012, 10:55 pm

      Gary, when I said you hadn’t yet given your risk parameters, I was referring to the percentage of your total worth that you put at risk, not your strategy for when to sell; it’s perfectly responsible to play your risky game, whether you think it’s risky or not, if you use money that you can afford to lose. If you have a strategy that works, the rare black swan setback won’t break you if you employ responsible money management.

    • mario cavolo April 5, 2012, 5:17 am

      JJ….!! “why bother with income taxes, or for that matter with people having jobs at all? Everyone can just work at a government job and drink coffee and read the paper.”

      Wow!…what a fabulous revealing comment. To a certain degree and within a certain context, that is exactly where the U.S. society and system is heading. Here’s my logic if we can call it that:

      1. The top 40% can easily survive, because they are doing better than ever.
      2. The top 20% and top 5% are ridiculously wealthy.
      3. The bottom 40% will need to be and ARE being bailed out, as indeed, they already are, but at enormous cost…literally, trillions as we all are witnessing. That is why I agree with the idea of a constantly expanding global GDP in the trillions as suggested by Pepsi’s CEO…(earlier post)
      4. Social programs/benefits like health care and other types of support including food stamps type programs will continue to expand; because they have to, they absolutely have to. This group of former middle class Americans are going to be more and more dependent, on the dole, not because they asked for it, but because the circumstances of the society placed them there. The govt’ MUST and WILL respond to this new normal reality.
      5. And in this scenario, of course with constantly expanding global money supply and GDP and inflation into more and more trillions, the purchasing power of the currencies by which this is all being executed, will continually fall.

      TWO POINT CONCLUSION:

      1. Those top 40% referred to earlier will be fine; because while in this expanding monetary context, they will see their purchasing power decline, but they won’t care because they have plenty. If you have a million and your currency value suddenly gets cut in half, you still have $500,000, not a big problem.

      2. The bottom 60% will be fine too, because they’re being supported more and more by the govt. They will live more and more at the daily basic survival level like billions of people do here in Asia. They won’t like it, and its pissing alot of people off, and creating all sorts of controversy, but in the end, it will and is happening. The traditional middle class sector of America is all but destroyed, nothing further to discuss on that sad point.

      Bingo. Beautiful. The new normal. Frankly, its a pretty clear and reasonable scenario. Of course I am not saying it is admirable or good, I am saying its a reasonable picture of global reality in terms of changing societies, governments and the economic system.

      Cheers, Mario

  • Rich April 4, 2012, 5:56 pm

    Re “Some traders we know have bragged that they saw the October 1987 crash taking shape that summer, like dark cumulus clouds on the horizon.”

    I was not a trader, but a broker in August 1987 when I booked the Chemical Bank Club on one of the top floors at the foot of Manhattan with a clear view of the WTC Towers, the Harbor and the Bridges.

    The topic was ‘The End of the Trend.’

    Although it was the exact day of the 1987 market top and the rich and famous were booked, attendance was spotty to say the least. By 19 October 1987 most had forgotten. Such is human nature.

    Rick’s thesis may demonstrate even more destructively in this day of High Freq AlgBot derivatives without collateral, third party guarantors, or transparency.

    We had our warnings with flash crashes, 0MFG JPM defaults and naked derivative shorts while Wall Street Masters of the Universe collected their bonuses and did not go to jail.

    I am standing for office to do something about that and clean the game up for all.

    Still, the perversity of human nature plays on through until stopped.

    Sometime this summer we may again see a hideous crash to end 0 and incumbent re-election hopes, if not Ron Paul’s, he who has warned us a long time, yet unheeded and unelected President.

    Meanwhile, will not be surprised if the lows for today may be in…

  • Terry S April 4, 2012, 5:51 pm

    “Open the Pod Bay doors, Hal.”
    “I’m afraid I can’t do that, Dave.”
    “Open the Pod Bay doors, Hal!”
    …”Why don’t you take a stress pill, Dave, and think about what you are doing.”

  • redwilldanaher April 4, 2012, 4:46 pm

    I’m not sure if you were referring to my “musical chairs” analogy in the comments section under your “Will Q2 Begin with a Lurch?” essay Rick but I’m sticking to it if that be the case!

    Great essay today as usual.

    I’d like to pose a a few questions to the “manipulation skeptics” and also the “solve it from within” crowd.

    First off, one for the manipulation skeptics:

    1. If Cramer’s small fund could regularly pull off significant manipulation in the big indices (and thanks to correlations and logical extensions thus many more markets), then why is it so hard for y’all to imagine what can be done by an extremely organized and powerful, practically all-knowing “few” that operate above the laws that they write? This run-on question could have ran on and on but I think most should get the gist by now.

    And now for the solve it from within crowd:

    2. Please enlighten me as to what is left in this society, this government, this so-called culture that hasn’t been corrupted to this point. Please explain why the trend has been one of near constant disintegration and decline no matter which politician has been installed where. Would you do this for me?

    As for the true-believers in US Corp. Profits best represented locally of course by Gary L., I suggest that you read something as basic as this somewhat recent piece by Charles Hugh Smith:

    http://www.oftwominds.com/blogfeb12/phantom-profits2-12.html

    It doesn’t get into the fraud accounting or the illegal profits that say a Catherine Austin Fitts would highlight but nonetheless it does get to the heart of how things have been engineered with the help of course of the FED’s black magic to make everything appear to be improving to fool the proletariat yet again.

    For the love of God please stop swallowing the propaganda with such great enthusiasm. It nauseates me.

  • ken horn April 4, 2012, 4:24 pm

    Rick, remember a few weeks ago, when we spoke in person? We were discussing the Market & I said to you, “I don’t know when the “big hit” will take place, but, I DO know that you, me, & everyone on this thread will be more “long the market” than we would like to be when it finally occurs.

    • Rick Ackerman April 4, 2012, 8:43 pm

      I was (of course) a permabear when I worked on the PSE floor, and the only time I can remember being massively long was at the closing bell on Friday, October 16, 1987. I thought that the Dow’s being down 108 points that day was the “blood running in the streets” that Baron Rothschild famously said represented real opportunity. Who knew that the real blood was yet to flow?

      I was so sure of my impending, contrarian success that I didn’t even bother to cover 180 Cray Research October 70 puts that I was short when the bell rang. With the stock down sharply that day, settling near 70, I could have covered those puts for $25 apiece. Came Monday, the stock was indicating $37, meaning that the nearly 18000 shares that had been put to me for $70 were now worth $37; the puts I’d been short for $25, worth $3300 apiece.

  • fallingman April 4, 2012, 4:22 pm

    Imagine being one of the remaining specialists on the floor when the high speed panic manifests itself.

    Visions of the abattoir.

  • John Jay April 4, 2012, 2:53 pm

    I think the corporate take over of the US economy/legal system is now so complete, surviving a “Flash Crash” may not save you anyway. Was MF Global an anomaly, or a warning shot over the bow? I know everything I have in CDs, Social Security, US government paper, and even my checking account is not really there. What is there is a promise to pay if I ask for my money back. If the time comes when everyone wants it back at the same time, a la MF Global, the first one in line gets it all.
    And first in line are GS/JPM, Hedge Funds, Central Banks, etc. In a real crash situation the US government can and will simply outlaw PMs and demand you turn them all in. A simple system of rewards to informers will make it impossible for you to spend your gold and silver. And when you turn your PMs in, they will tax it on the spot before they give you an FDR price for it.
    I firmly believe if and when an all out collapse occurs, there will be no “Safe Haven.” My only hope continues to be that Europe and especially Japan are going down before we do and we are the last man standing. Sad to say, I am now rooting for our Ponzi scheme to outlast all the others.

  • Mark Uzick April 4, 2012, 7:03 am

    Since a flash crash, by definition, has no staying power, I don’t think it has much meaning except to speculators using leverage; even a real crash isn’t really important in itself as long as fundamental value hasn’t changed; and, in fact, in that case it would represent an opportunity to buy at a discount.

    The real crash to fear is the crash of the dollar, whether in a flash or in a span of several years, the dollar has no fundamental value and so its loss of purchasing power will be a one way street.

    It’s perfectly rational to keep endlessly bidding up stocks with dollars; after-all, how many chances will we have to get something for nothing?

    If you fear that economic hardship will cause the value of companies to drop in real value, then buy precious metals and then switch between metals and stocks, but stay away from excessive exposure to fiat paper currencies.

    &&&&&&

    This idea of getting something (i.e., goods and services) for nothing (i.e., fundamentally worthless dollars) may be helping to push stocks higher as you suggest, but I doubt it is much of a factor. As you undoubtedly recognize, were this idea to seize the proletarian mind, it would produce hyperinflation overnight — and, yes, much higher stock prices. In the meantime, my guess is that The Mother of All Bear Rallies is a creature, not of inflationary mindset, but of allocation schemes that require money managers to deploy certain sums in shares come hell or high water. As to the question of whether this is perfectly rational behavior: It is, but only in the glue-sniffing precincts of Wall Street and in such impregnable redouts of ignorance as the newsrooms. RA

    • Mark Uzick April 4, 2012, 11:13 pm

      Rick: This idea of getting something (i.e., goods and services) for nothing (i.e., fundamentally worthless dollars) may be helping to push stocks higher as you suggest, but I doubt it is much of a factor.

      Really? So you don’t think that it’s much of a factor that people who are unable to get a return on their bank accounts and see their cost of living rising ever more rapidly are seeking out stocks and other risk assets in a desperate attempt to earn dividends and preserve their wealth?

      &&&&&&

      That’s stretching the point that people believe they are getting someting for “nothing”. The dollar may be worthless intrinsically, but it is still fungible, and it can still be exchanged for anything besides stocks. RA

  • Bradley April 4, 2012, 6:50 am

    I’m confused.

    Rick, your site’s homepage lists various market positions either as actionable advice or open. The entire purpose of the site, as I see it, is to discuss making wagers, (the background photo is of a racetrack!), in the equity and futures markets.

    Taking risk seems an essential part of what everyone here is a part of. The positions I read about, advocated by you and others here, seem to be VERY well constructed, limited risk positions, which do not rely on luck or hope for success. Nevertheless, they are placed in the markets, (subject to TPTB and DaBoys having their way with them), and are meant to pull as much money out of the same system that Gary or anyone else is working with.
    The main difference between your position and Gary’s seems to be that he is more willing to take larger, unhedged positions, and seems willing to believe that “all this” can go on for longer than you think it can.

    If the end is nigh, and a flash crash or some other even more terrifying occurrence is inevitable, why put a dime of money, or a minute of the limited and precious time we have into the rigged, manipulated, mean-spirited world of Wall Street anyway?

    &&&&&&

    Bradley: You and other “lurkers” who read only my free commentary have no idea what we are doing on the tout side of the service. This morning, for instance, we are seeking to re-establish a position in GDXJ at 22.74, a downside target that was first identified weeks ago and which helped us avoid bottom-fishing prematurely.

    Generally speaking, the philosophy of Rick’s Picks, using Hidden Pivots and a proprietary entry technique called “Camouflage,” is to risk no more than literal pocket change when initiating a trade. This applies to day trades, swing trades, or to trades in which one seeks to establish a long- or intermediate-term position. It should NEVER be necessary to risk more than nickels and dimes when one establishes a position — in any vehicle, be it a stock, an option, an index future, a commodity contract. If you take a free trial subscription (offered on the home page), which will give you 24/7 access to the chat room, you can ask subscribers yourself how successful we’ve been at this. RA

    • Mark Uzick April 4, 2012, 7:15 am

      Bradley: If the end is nigh, and a flash crash or some other even more terrifying occurrence is inevitable, why put a dime of money, or a minute of the limited and precious time we have into the rigged, manipulated, mean-spirited world of Wall Street anyway?

      Didn’t you already answer this question before you even asked it? Just read your 2nd paragraph.

      I think that the issue with Gary may have something to do with money management, although I have no idea why they’re assuming that Gary is taking foolish risks since he hasn’t specified his risk parameters.

    • Bradley April 4, 2012, 5:21 pm

      Rick,
      My post does not question the success of your methods, and I think describes exactly what you wrote about in your reply, when I said that your positions “seem to be VERY well constructed, limited risk positions, which do not rely on luck or hope for success.”
      I am grateful to be able to read your site, and have written you privately to offer my help to make it better, (which your kind replies gave me the indication that they did). IMO, this is my penance for being a “lurker”.

      What I am wondering is what is the motivation for trudging into this swamp? Your are clearly a very intelligent person, and could make a good living in any number of ways, but choose to deal with daBoys and are concerned that at any time the whole thing could go up in flames, but there still is some motivator that keeps you in the game. “Just paying the bills” doesn’t seem enough. Is extracting money from daBoys at the bottom of it?
      No one goes to the racetrack with the intention of placing some well considered bets, while being certain that the place will burn to the ground in the near future, or do they?

      &&&&&

      It’s how I make my living, Bradley. Using the trading method I’ve developed over the last 15 years, it’s not that hard, either. As for the race track, if bettors see a nuclear mushroom cloud on the horizon, you can be sure they’ll be placing bets until the instant the firestorm hits. RA

  • Rick Ackerman April 4, 2012, 5:22 am

    More like, orchestrated to give DaScumballs a chance to shake down shareholders for some rock-bottom bargains. Look at Apple’s chart if you want to see how successful They were.

  • SD1 April 4, 2012, 5:20 am

    The flash crash was orchestrated for no other reason than to give retail bears the hope it would happen again.

  • Benjamin April 4, 2012, 5:16 am

    “[…] a crash of that kind could have occurred only because the electronic system itself had gone HAL-9000 wacky.

    Wacky… or much more sane than the humans? Kinda creepy when you think about it. Will it really take a dumb machine to show us how things are? Have we sunken so far into oblivious idiocy? And if so, then who’s to say the machine can show us anything? Seriously. As far as this “recovery” has been spun, it wouldn’t surprise me at all if another, bigger flash-crash was hailed as great news… with entirely too many people believing it to be so (or just continuing to play along like they thought it was, even though they consciously knew it wasn’t).

    On another note, I have to wonder if Timothy Leary would’ve fared better than your friend 🙂

  • jeff kahn April 4, 2012, 3:43 am

    I know one thing. The greater the manipulation, the harder the crash.