Saturday, April 11, 2009

Market Liquidity

Zero Hedge had this article on Friday, "The Incredibly Shrinking Market Liquidity, Or The Upcoming Black Swan of Black Swans".

The analysis mostly went over my head (they are discussing the impact of quant funds and program traders on the market liquidity, I think), but then I remembered a comment on the Yahoo SKF board some time ago by a former trader at a major financial institution.

He was referring to a day in late March when the market did the intraday about-face with less than 1 hour remaining. The market had been declining, and then came a steep sell-off. When it seemed like it was going to bust through the support, it made a V-shape recovery that came out of nowhere. The SKF poster said that was when JPM (J.P.Morgan Chase) allegedly bought 1500 lots of S&P futures. According to him, that one trade probably triggered 10,000's of other trades in stocks, options, derivatives, T-bills, Nikkei, DAX, etc. Which in turn, I would assume, triggered 10,000's of trades. Possibly millions of trades emanated from JPM's purchase of S&P futures.

JPM's trade created an arbitrage opportunity that started the cascade of activities around the globe, resulting in massive amount of money moved around in a very short period of time, while the slow retail investors/traders watched with their jaws dropped.

The above Zero Hedge article says as much as one-third of the trades are quant trades but it is probably higher. Why? Because increasing number of institutional investors and hedge funds are using the dark pool, where they can trade anonymously without regulators' oversight. Institutions claim that the dark pools have no impact on market liquidity, but just take a look at the recent market volume. It is not low, but not high either given the monstrously huge run-up it has had.

Here's a link to Investors Business Daily's articles on dark pools. NYSE has one, Nasdaq has one, GS, MS (Morgan Stanley), Merrill Lynch each has one, Europeans have theirs.

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