Trader Talk

Dow Bounce...Short Covering? — Pisani's Trader Talk

Time for a bounce? I was on the phone with one of the oldest traders I know (up 6 percent this year) as the Dow hit down 500 a short while ago.

"Hold on, I gotta call you back," he said. When he did, 15 minutes later, he had covered all his shorts.

Why? "Look, we are down 15 percent in 2 weeks...even if earnings are not as good as people think, at 11 times forward earnings with interest rates near zero, it's hard to argue that stocks are overpriced."

This trader has tremendous contacts with prime brokers and macro hedge funds. I asked him about the two Big Sideshow Issues that traders are talking about: the so-called liquidity crisis and the role of high frequency traders in the downturn.

1) is this a liquidity crisis? Has this morphed from just worries over lower global growth rates and the deficit and the S&P downgrade to a situation where there is massive margin calls?

This trader had just spoken with 3 prime brokers, and said there was no sign of a massive liquidity crisis. Prime brokers are not calling their clients and demanding more money en masse. "I've spoken with 20 hedge fund managers in the last two days, no one has had a margin call," he said.

That doesn't mean people haven't been raising cash, of course, and that's what he thinks is going on: this is an old-fashioned panic.

No wonder traders have become more interested in behavioral economics.

"The trading community is like a massive horde of wildebeests. You know the story about them: there are thousands of wildebeests standing on the edge of a river in Africa. They're standing there; no one's crossing. Suddenly one walks into the water, and then everyone does."

"Hedge funds are not heavily leveraged...this is not 1998...when everyone and their brother was in," he said. "There may be some retail margin calls, but leverage is much lower than it was even a few years ago."

2) What's the role of high frequency traders (HFTs)? He noted the obvious: HFTs thrive in high volatility markets; this is the kind of market they make money in.

"What HFT's do is force you to trade in advance," my trader friend said, who plays against them every day. "It's very difficult to see the inflection points fast enough--5 upticks in a row? It happens in a heartbeat. What they take away is the ability to bet the psychology of the market minute by minute, because you can't respond to an event as quickly as they can."

But don't go making the leap that the market is now somehow controlled by HFTs. While HFTs are indeed nearly 60 percent of trading, don't kid yourself: don't go blaming them for this downturn. Do you seriously think this would not have happened had they not been there? That panics only started when HFTs came around a few years ago?

"On any given moment, I won't deny that HFTs have an advantage over humans, but long term it doesn't matter," my trader friend said.

As for the market...plenty are looking for some kind of bottom. "You have to have an uncle point," another trader wrote to me, "and we have to be close."

"This feels like a wash out today," another wrote.

The problem, of course, is that in this environment everyone has become a technical analyst and a short-term momentum trader. I asked my friend who had just covered all his shorts how long his position would last.

He said he was looking for a 300-400 point bounce in the Dow in the short term. That's it?

"When you're trading long in a down market, you have to satisfied with a lot less," he said, and hung up.

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