The Economy, stupid

[southsider2k5]

I was thinking about also trying to explain the difference between venues - exchanges, light pools, dark pools, offer nets, etc. - but I just don't have the time to type all that out. Venue is key to understanding when an order is fair-viewed or not, and when it has to be or not, and to what audience, before execution.

 

When a company internalizes order flow, they act as another market maker. They assume risk, even if momentarily, by taking on a trade and then offsetting it with another. Companies that use internalization have to have the operation completely separate from their brokerage operations as dictated by the SEC. A brokerage unit's only objective is to fill orders. There is also the misconception that internalization somehow hurts customers, which isn't true. In the end, even if a company didn't internalize order flow, the specialist in a particular area would make that same profit. A customer is always going to sell at the bid and buy at the offer, whether it is GS or a specialist in NYSE making the profit, it doesn't make a difference.

[NorthSideSox72]

When a company internalizes order flow, they act as another market maker. They assume risk, even if momentarily, by taking on a trade and then offsetting it with another. Companies that use internalization have to have the operation completely separate from their brokerage operations as dictated by the SEC. A brokerage unit's only objective is to fill orders. There is also the misconception that internalization somehow hurts customers, which isn't true. In the end, even if a company didn't internalize order flow, the specialist in a particular area would make that same profit. A customer is always going to sell at the bid and buy at the offer, whether it is GS or a specialist in NYSE making the profit, it doesn't make a difference.

All true. But there are still rules for what orders can be or can't be internalized, and further rules about where transactions have to be shown if they are going outside the walls.

 

[Cknolls]

There are some subtleties here, which I couldn't possibly answer in the space here. Plus, I sort of work in this space, so I am limited in what I can say. I really wish we could just sit down over a beer so I could explain it.

 

 

Call the White House maybe they can fit you guys in too!

[southsider2k5]

Call the White House maybe they can fit you guys in too!

 

I'm sure once Obama accuses us traders of acting stupidly, he can get us in for a beer...

[NorthSideSox72]

I'm sure once Obama accuses us traders of acting stupidly, he can get us in for a beer...

I think between CKnolls, Kap, you and I, we could probably help teach Obama a thing or two. We could also teach him about good beer.

 

[southsider2k5]

All true. But there are still rules for what orders can be or can't be internalized, and further rules about where transactions have to be shown if they are going outside the walls.

 

And there are disclosure rules about all of it. Its not a big secret or a big conspiracy. It also doesn't hurt the customers one single penny. In fact most companies use internalization to give small price improvements to their customers which they can then use in their advertising campaigns.

[southsider2k5]

I think between CKnolls, Kap, you and I, we could probably help teach Obama a thing or two. We could also teach him about good beer.

 

lol. Heck, maybe I can try to get him to call me stupid. I'd love a free trip to Washington, oh and a free beer!

[lostfan]

lol. Heck, maybe I can try to get him to call me stupid. I'd love a free trip to Washington, oh and a free beer!

You'd have to get me invited too, preferably after rush hour though.

[southsider2k5]

You'd have to get me invited too, preferably after rush hour though.

 

Why don't you come break into my house, and we can go from there?

 

[/green]

[lostfan]

Why don't you come break into my house, and we can go from there?

 

[/green]

Well technically I'd have to break into my own house right?

[southsider2k5]

Well technically I'd have to break into my own house right?

 

Crap. I was never good at details.

[kapkomet]

Nicely played.

[Balta1701]

This will be interesting.

The Commodity Futures Trading Commission plans to issue a report next month suggesting speculators played a significant role in driving wild swings in oil prices -- a reversal of an earlier CFTC position that augurs intensifying scrutiny on investors.

 

In a contentious report last year, the main U.S. futures-market regulator pinned oil-price swings primarily on supply and demand. But that analysis was based on "deeply flawed data," Bart Chilton, one of four CFTC commissioners, said in an interview Monday.

 

The CFTC's new review, due to be released in August, adds fuel to a growing debate over financial investors who bet on the direction of commodities prices by buying contracts tied to indexes. These speculators have invested hundreds of billions of dollars in contracts that were once dominated by producers and consumers who sought to hedge against oil-market volatility

[lostfan]

Cue Southsider to call BS

[southsider2k5]

Cue Southsider to call BS

 

If it is true, I want to see prosecutions.

[Balta1701]

If it is true, I want to see prosecutions.

It's clearly not illegal to drive the price of something up to ridiculous values (see: the housing market) whether or not its worth it.

[NorthSideSox72]

It's clearly not illegal to drive the price of something up to ridiculous values (see: the housing market) whether or not its worth it.

Correct - its not. If a buyer and seller will agree on a price, then by nature its not illegal.

 

But I agree with SS, if these traders were actually able to manipulate prices over the long term (beyond single contract periods), which would be an impressive feat, then they should indeed be prosecuted.

 

The article's vague description of the use of indices is sort of bizarre, though. Seems to have been written by someone without a good understanding of those markets. That description could mean all sorts of things.

 

[NorthSideSox72]

I'm really disappointed in the Journal's article on this, purely from a perspective of having writers write about commodities who don't seem to know commodities. Look at these two paragraphs:

 

The debate over speculators underscores the shifting nature of commodities trading in recent years. Before the mid-1990s, these markets were dominated by entities that had physical dealings with the underlying commodity, and "speculators" who often took the opposite position, providing liquidity to markets.

 

But a new group of investors has emerged in recent years. Those who want to bet on commodities prices have increasingly put their money in indexes that track the value of futures contracts, in which investors promise to pay a certain amount in the future for oil and other commodities. As of July 2008, financial investors had about $300 billion riding on these indexes, roughly four times the level in January 2006, according to the International Energy Agency, a Paris-based watchdog.

 

First of all, this basically says... before, there were speculators, and now, there are SPECULATORS. LOL.

 

Second, what indices are they talking about? Do they mean equitized commodity funds like Powershares? Do they mean actual exchange-traded index futures, which aren't commodities anyway? Do they mean true indicies of futures contracts - and if so, where are they seeing those listed?

[Y2HH]

Correct - its not. If a buyer and seller will agree on a price, then by nature its not illegal.

 

But I agree with SS, if these traders were actually able to manipulate prices over the long term (beyond single contract periods), which would be an impressive feat, then they should indeed be prosecuted.

 

The article's vague description of the use of indices is sort of bizarre, though. Seems to have been written by someone without a good understanding of those markets. That description could mean all sorts of things.

 

Now this is something we can agree on.

 

I've been in the market almost 10 years (not a long time in terms of experience) but two of the worst things I've witnessed was the removal of the uptick rule (shorts betting on falling stocks), and then speculators who would drive the price of a commodity to obscene levels. Internet based trading has made performing things that were once impossible almost too easy -- when you see regular middle class people playing the speculation game it's when you know it's too easy. It's almost like gambling, only they aren't the ones controlling the swing -- someone else is -- and if they happen to get lucky they get to ride the wave, if not they're one and done.

 

For a while, what they were doing was buying up oil contracts right before inventory counts -- when these are purchased they are considered out of inventory even though they never actually move -- and when the inventory counts would come in low, the prices would artificially rise -- then they'd dump those contracts back onto the market and others buying into the hype would buy them. Repeat this process. It's a process that feeds upon itself not unlike short selling without an uptick rule -- as the price cascades down, automatic covers are triggered and the selling spree feeds upon itself, just in the opposite direction of what they were doing with the commodities market.

 

I think either method of trading is evil. Betting on a stock losing value is evil as far as I'm concerned -- just as I view pumping up commodity prices to be evil, but even more vile as commodities are things people need to survive, like food, gasoline, etc.

 

Anyway, I don't want to get too long winded here, a lot of this stuff is convoluted and complicated, and it's how they've gotten away with it for so long -- the rules in place that oversee these types of things are full of holes, and people with money have the means to maneuver the system.

[Y2HH]

I'm really disappointed in the Journal's article on this, purely from a perspective of having writers write about commodities who don't seem to know commodities. Look at these two paragraphs:

 

 

 

First of all, this basically says... before, there were speculators, and now, there are SPECULATORS. LOL.

 

Second, what indices are they talking about? Do they mean equitized commodity funds like Powershares? Do they mean actual exchange-traded index futures, which aren't commodities anyway? Do they mean true indicies of futures contracts - and if so, where are they seeing those listed?

 

I'm not really sure what that article was trying to say, but the commodities market has become a gamblers paradise...only in this paradise, with enough money, it's possible to actually gain some form of pricing control.

 

The original intent of trading commodities was the end goal of actually using them. Speculators are people trading these commodities without ever intending to take possession, but just flipping it off for a profit to a person/company who actually needs/wants to take possession.

 

For example, Hershey or Tootsie Roll will have traders in the cocoa pit -- their job is to buy cocoa contracts (and accept delivery) to use in their chocolate products. Their goal is to keep the cocoa affordable so their product costs don't spike, without allowing one of the many competitors to get too much of the current market, as that would spike prices. Remember all of these people intend on taking delivery of these contracts for the physical cocoa. Speculators came into this game realizing it'd be REALLY easy to make money without having to actually do anything in terms of creating a product. Their thought process went like so -- with enough money, they can go in and buy up a ton of contracts, and then resell them to people who need them since we are talking about a finite product. There is only so much cocoa to be harvested, so they have no choice but to buy it if they want to keep making their products...who cares if the price of chocolate rises and the consumer on the other end get f***ed over by really expensive chocolate bars...we got ours! For a while this worked, because it added liquidity to the markets -- but when the really big guys caught on it went haywire.

 

As I see it, that's why they did in the oil market...because where people would probably stop buying chocolate bars if they cost 4$+ each -- they can't/won't just stop driving, as most of them HAVE TO DRIVE in order to work.

 

It was perfect.

 

Now I may be a little off on some of my thinking here, but not by much, IMO.

Edited July 29, 2009 by Y2HH

[NorthSideSox72]

I'm not really sure what that article was trying to say, but the commodities market has become a gamblers paradise...only in this paradise, with enough money, it's possible to actually gain some form of pricing control.

 

The original intent of trading commodities was the end goal of actually using them. Speculators are people trading these commodities without ever intending to take possession, but just flipping it off for a profit to a person/company who actually needs/wants to take possession.

 

For example, Hershey or Tootsie Roll will have traders in the cocoa pit -- their job is to buy cocoa contracts (and accept delivery) to use in their chocolate products. Their goal is to keep the cocoa affordable so their product costs don't spike, without allowing one of the many competitors to get too much of the current market, as that would spike prices. Remember all of these people intend on taking delivery of these contracts for the physical cocoa. Speculators came into this game realizing it'd be REALLY easy to make money without having to actually do anything in terms of creating a product. Their thought process went like so -- with enough money, they can go in and buy up a ton of contracts, and then resell them to people who need them since we are talking about a finite product. There is only so much cocoa to be harvested, so they have no choice but to buy it if they want to keep making their products...who cares if the price of chocolate rises and the consumer on the other end get f***ed over by really expensive chocolate bars...we got ours! For a while this worked, because it added liquidity to the markets -- but when the really big guys caught on it went haywire.

 

As I see it, that's why they did in the oil market...because where people would probably stop buying chocolate bars if they cost 4$+ each -- they can't/won't just stop driving, as most of them HAVE TO DRIVE in order to work.

 

It was perfect.

 

Now I may be a little off on some of my thinking here, but not by much, IMO.

Well, one thing that I think you (and many) are missing here, is that price speculators are not at all new. In fact, the market doesn't work well without them. They have been there from the beginning. The methods and instruments have changed, technology has changed, but the players in the market really have not.

 

[Y2HH]

Well, one thing that I think you (and many) are missing here, is that price speculators are not at all new. In fact, the market doesn't work well without them. They have been there from the beginning. The methods and instruments have changed, technology has changed, but the players in the market really have not.

 

I forgot to add something to this. I agree with this point and I do realize that they're not new. I think the system worked fine like that until the HUGE hedge fund institutions started getting involved. We are no long talking some millions here, but billions upon billions they were doing this with, and that caused the huge swings that we hadn't really seen in such markets before they entered it. Essentially they took a level playing field and came in with so much money, it was no longer level, and this gave them too much control.

Edited July 29, 2009 by Y2HH

[Cknolls]

I think between CKnolls, Kap, you and I, we could probably help teach Obama a thing or two. We could also teach him about good beer.

 

 

[southsider2k5]

I forgot to add something to this. I agree with this point and I do realize that they're not new. I think the system worked fine like that until the HUGE hedge fund institutions started getting involved. We are no long talking some millions here, but billions upon billions they were doing this with, and that caused the huge swings that we hadn't really seen in such markets before they entered it. Essentially they took a level playing field and came in with so much money, it was no longer level, and this gave them too much control.

 

Historically, this is not true at all. There have been long periods of time where markets were dominated by the few. The playing field really didn't get leveled until the emergence of internet trading and the crash of the price of trading. Trading in general is more wide open to the masses than it has ever been.

[Y2HH]

Historically, this is not true at all. There have been long periods of time where markets were dominated by the few. The playing field really didn't get leveled until the emergence of internet trading and the crash of the price of trading. Trading in general is more wide open to the masses than it has ever been.

 

I don't mean that at all, the fact that anyone can be on the field is one thing -- that doesn't mean it's level. What I meant is that when it comes to commodity speculation, the big hedge funds (with billions in their cash coffers) weren't involved until the last few years. I'm not sure when they jumped on board, but I know they did. At one time they capped their involvement in these markets to something like 5% of their total funds, but when they realized what they could do, that number expanded a lot, and then we had them pouring billions into commodity speculation.

 

50 guys playing with 10,000$ that were once unable to get on the field is one thing -- they can now freely trade in a very easy and affordable manner...that's not my point. My point is when one of those 50 comes in and throws 2,000,000,000 on the table, the playing field isn't level. Just because you can play doesn't mean it's balanced. Even rich traders (individuals) don't speculate with billions...whereas hedge funds started to do just that.

Edited July 29, 2009 by Y2HH