It was an invitation-only party (crabs, cocktails and a D.J. on a moonlit dock) thrown by Jane Street, a secretive E.T.F. trading firm that, after years of minting money in the shadows of Wall Street, is now pitching itself to some of the largest institutional investors in the world.

And the message was clear: Jane Street, which barely existed 15 years ago and now trades more than $1 trillion a year, was ready to take on the big boys.

Much of what Jane Street, which occupies two floors of an office building at the southern tip of Manhattan, does is not known. That is by design, as the firm deploys specialized trading strategies to capture arbitrage profits by buying and selling (using its own capital) large amounts of E.T.F. shares.

It’s a risky business.

As the popularity of E.T.F.s has soared — exchange-traded funds now account for a third of all publicly traded equities — the spreads, or margins, have narrowed substantially, making it harder to profit from the difference.
And in many cases, some of the most popular E.T.F.s track hard-to-trade securities like junk bonds, emerging-market stocks and a variety of derivative products, adding an extra layer of risk. […]

While traders at large investment banks watched their screens in horror, at Jane Street, a bunch of Harvard Ph.D.s wearing flip-flops, shorts and hoodies, swung into action with a wave of buy orders. By the end of the day, the E.T.F. shares had retraced their sharp falls.

It is not only Jane Street, of course. Cantor Fitzgerald, the Knight Capital Group and the Susquehanna International Group have all capitalized on the E.T.F. explosion.

And as these firms have grown, so has the demand for a new breed of Wall Street trader — one who can build financial models and write computer code but who also has the guts to spot a market anomaly and bet big with the firm’s capital. […]

Here is a small sample of Jane Street’s main traders: Tao Wang (doctorate in philosophy and finance from the National University of Singapore), Min Zhu (master’s in chemistry, Columbia), Brett Harrison (master’s in computer science with a focus in artificial intelligence, Harvard) and Srihari Seshadri (bachelor’s in computer science, Carnegie Mellon).

{ NY Times | Continue reading }

oil on Masonite { Grant Wood, Birthplace of Herbert Hoover, 1931 }

A recent Wall Street Journal/NBC News poll found that 49% of Americans still believe the U.S. economy is in recession, even though we are now in the sixth year of the recovery. […] If investing when others are skeptical has historically been a successful strategy, why don’t more investors do so? […] Taking advantage of the findings discussed earlier requires investing when the economy and market seem to be at their worst, and rebalancing when conditions appear to be the best. This is counterintuitive for many investors, who tend to wait for confirming evidence before acting. This is related to herd behavior, the tendency to follow the crowd with portfolio decisions. Investing when others are skeptical is emotionally difficult but, as we’ve shown, tends to be when rewards are the greatest.

{ JP Morgan Funds | PDF }

related { It is not possible for a human to know whether Bank of America made money or lost money last quarter. }

art { Jim Campbell, Ambiguous Icon #1 Running Falling, 2000 }

Since The Fed’s extension of Operation Twist (and subsequent unveiling of QE3) in 2012, the stocks of “weak balance sheet” companies are up over 100%. In that same period, the stock prices of “strong balance sheet” companies are up a mere 43%.

{ ZeroHedge | Continue reading }

The last 5 days saw “strong” companies outperform “weak” companies by the most in 3 years - something appears to be changing.

{ ZeroHedge | Continue reading }

A quarter of all public company deals may involve some kind of insider trading. […] The study [PDF], perhaps the most detailed and exhaustive of its kind, examined hundreds of transactions from 1996 through the end of 2012.

{ NY Times | Continue reading }

Long ago, stock trades were reported over ticker tape, and one type of manipulation was called “painting the tape.” Traders would enter orders to give the appearance of activity in a stock to entice others to buy shares, thus pushing the price higher.

Today, a slightly more sophisticated scheme is called “banging the close,” in which transactions are made in one market at the end of the day to benefit a trader’s positions in another market, say derivatives. Same scheme, different means. […]

The growth of high-frequency trading firms and transactions executed on alternative trading systems, called dark pools, have made it more difficult to police potential manipulative conduct. High-frequency traders buy and sell millions of financial instruments but rarely hold a position for more than a day. While such trading provides greater liquidity to the markets, helping to lower costs for all investors, it can also offer new opportunities for manipulating prices. […]

Manipulation can also involve benchmark indexes, which are incorporated into a wide variety of transactions, including mortgage interest rates. When an index relies on reports provided by rival market participants, the temptation to furnish false information to affect its value can be powerful because a small shift in value can affect billions of dollars. Several large banks have already paid billions in penalties for manipulation of the London interbank offered rate, or Libor, and investigations are gaining steam into how currency prices were reported in the foreign exchange markets.

{ NY Times | Continue reading }

High frequency trading. I won’t go into the details, but basically it has become an arms race of being a millionth of a second faster than the other guy. The exchanges (Nasdaq and NYSE) started offering co-location within their facilities and traders started fighting for the best physical real estate within the co-location center (ie. literally trying to be a few feet closer to the exchanges’ computers).  Some of the high frequency traders complained about how ‘unfair’ it was to be a few feet farther away.  The exchanges conceded and added ‘latency’, basically a few feet of cable, so everyone within the co-location center is equidistant. It baffles me financial progress is moving in this direction.

Prediction by ‘experts’/pundits. Why do people still believe in pundits and ‘experts’ on TV? If ‘experts’ could predict the future with any accuracy, they would be doing something else. They are not always wrong, they are simply not right consistently enough to provide meaningful value. I’m always surprised how confident and certain people sound on CNBC (I rarely feel sure of anything). Keynes got it right when he said, “If you must forecast, forecast often.”

{ Quora | Continue reading }

On average, ATD made less than a penny on every share it traded, but it was trading hundreds of millions of shares a day. Eventually the firm moved out of Hawkes’s garage and into a $36 million modernist campus on the swampy outskirts of Charleston, S.C., some 650 miles from Wall Street.

By 2006 the firm traded between 700 million and 800 million shares a day, accounting for upwards of 9 percent of all stock market volume in the U.S. And it wasn’t alone anymore. A handful of other big electronic trading firms such as Getco, Knight Capital Group, and Citadel were on the scene, having grown out of the trading floors of the mercantile and futures exchanges in Chicago and the stock exchanges in New York. High-frequency trading was becoming more pervasive.

The definition of HFT varies, depending on whom you ask. Essentially, it’s the use of automated strategies to churn through large volumes of orders in fractions of seconds. Some firms can trade in microseconds. (Usually, these shops are trading for themselves rather than clients.) And HFT isn’t just for stocks: Speed traders have made inroads in futures, fixed income, and foreign currencies. Options, not so much. […]

By 2010, HFT accounted for more than 60 percent of all U.S. equity volume and seemed positioned to swallow the rest. […] For the first time since its inception, high-frequency trading, the bogey machine of the markets, is in retreat. According to estimates from Rosenblatt Securities, as much as two-thirds of all stock trades in the U.S. from 2008 to 2011 were executed by high-frequency firms; today it’s about half. In 2009, high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day. Speed traders aren’t just trading fewer shares, they’re making less money on each trade.

{ Bloomberg | Continue reading }

related { Today’s Comforting Stat: Hedge funds are a trillion dollars in debt }

REITs [Real Estate Investment Trust] are sold like stocks, and they’re held by many individuals and institutional investors. You might have a REIT in your retirement fund. REITs are trusts that own and develop property and earn rental income. […] “They are forced by law — a law created in 1960 — that provides that real estate investment trusts have to meet certain tests,” says Brad Thomas, editor of the Intelligent REIT Investor. “And if they do, they are forced to pay out 90 percent of their taxable income in the form of dividends.” Those dividends are a regular stream of income, and they’re what make REITs attractive to investors.

I put down $513.94 on a REIT index fund. It’s basically a smorgasbord of many different REITs. It contains what you might expect — REITs that own apartment buildings and shopping centers. But Thomas says the range of REITs today goes far beyond that, “from billboards to prisons to cell towers, campus housing. Even solar is on the horizon potentially.”

{ NPR | Continue reading }

related { Agents use a median 250 characters for homes listed under $100,000. For homes priced over $1 million, they go nearly twice as long, with a median 487 characters. }

related { If There Is A “Housing Recovery” Then This Chart Can’t Be Right }

In February 2012, a number of hedge fund traders noted one particular index–CDX IG 9–that seemed to be underpriced. It seemed to be cheaper to buy credit default protection on the 125 companies that made the index by buying the index than by buying protection on the 125 companies one by one. This was an obvious short-term moneymaking opportunity: Buy the index, sell its component short, in short order either the index will rise or the components will fall in value, and then you will be able to quickly close out your position with a large profit.

But February passed, and March passed, and April rolled in, and the gap between the price of CDX IG 9 and what the hedge fund traders thought it should be grew. And their bosses asked them questions, like: “Shouldn’t this trade have converged by now?” “Have you missed something?” […]

So the hedge fund traders began asking who their counterparty was. It seemed that they all had the same counterparty. And so they began calling their counterparty “the London Whale.” They kept buying. And the London Whale kept selling. And so they had no opportunity to even begin to liquidate their positions and their mark-to-market losses grew, and the risk they had exposed their firms to grew.

So they got annoyed. And they went public, hoping that they could induce the bosses of the London Whale to force him to unwind his possession, in which case they would profit immensely not just when the value of CDX IG 9 returned to its fundamental but by price pressure as the London Whale had to find people to transact with. And so we had ‘London Whale’ Rattles Debt Market, and similar stories.

The London Whale was Bruno Iksil [a trader working for the London office of JPMorgan Chase]. He had been losing, and rolling double or nothing, and losing again for months. His boss, Ina Drew, took a look at his positions. They found they had a choice: they could hold the portfolio and thus go all-in, or they could fold. They could hold CDX IG 9 until maturity–make a fortune if a fewer-than-expected number of its 125 companies went bankrupt, and lose J.P. Morgan Chase entirely to bankruptcy if more did. Or they could take their $6 billion loss and go home. What could they do if the bet went wrong and they had to eat losses at maturity? J.P. Morgan Chase couldn’t print money. So Drew stood Iksil down, and the hedge fund traders had their happy ending.

[…]

“Why did the interest rate on the Ten-Year Treasury peak at 4%? And why has it gone down since then? And why won’t it go back to its 5%-7% fundamental.” And they looked around. And they found Ben Bernanke. The Washington Super-Whale. […] From my perspective, of course, the hedge fundies’ analogy between the London Whale and the Washington Super-Whale is all wrong.

{ Brad DeLong | Continue reading }

{ Hedge-fund manager John Paulson’s wager on gold wiped out almost $1 billion of his personal wealth in the past two trading days as the precious metal plummeted 13 percent. Paulson started the year with about $9.5 billion invested across his hedge funds, of which 85 percent was in gold share classes. | Businessweek | full story }

Gold Sell-Off Biggest in 30 Years

Gold was diving 9.5%, reaching at its lowest level since February 2011 on Monday.

What Happened The Last Time We Saw Gold Drop Like This?

Why is gold plunging? The most important factor is that global inflation is falling, reducing gold’s value as a hedge against rising prices.

Did Goldman Sachs release a note encouraging clients to short gold right after receiving the Fed’s FOMC leak information, due to the leak itself?

So, it’s mid-March 2013 and, the S&P 500 is at 1550, right where I said it would be nine months ago. […] I see the S&P continuing to frustrate the majority (that is what markets do).  It may hit 1560-1580 prior to actually having a legitimate correction of 5-10%.  There is so much liquidity awaiting deployment upon a pullback that the pullback will be quick.  Later in the year, it’s very likely we’ll see 1600-plus on the S&P (September-November).  In my view, the market will be a good sell at that point, so will many credit products.  There is no way the Fed can shift its policy stance concurrent with having to immunize a $4 trillion balance sheet going into the end of a fiscal year.  2014 is likely to be challenging.
 
Enjoy this while it lasts. […]

The People’s Republic’s big issues will start in fiscal years 2013-2014.  China Merchants Bank, for example, is already seeing a bigger rise in bad-loan provisioning and lower good-loan growth than Western equity analysts think.  The CEOs of two large Brazilian companies, Vale and Petrobras, are starting to plan for China to “hit a wall” in 2015-2018. Essentially, China will look OK through April 2013 then big problems will hit the country.

Europe will not implode.

{ Secret top source/Minyanville | Continue reading }

Buffett’s Berkshire Hathaway and 3G said last Thursday they would buy Heinz for $23 billion in cash. Almost immediately, options market players noted there had been extremely unusual activity the day before the deal was announced.

On Friday, the U.S. Securities and Exchange Commission filed a suit against unknown traders who it said used a Goldman Sachs account in Switzerland to trade on purported inside knowledge of the transaction.

On Tuesday, the FBI said it was joining in as well.

{ Reuters | Continue reading }

A single mysterious computer program that placed orders — and then subsequently canceled them — made up 4 percent of all quote traffic in the U.S. stock market last week, according to the top tracker of high-frequency trading activity. The motive of the algorithm is still unclear.

The program placed orders in 25-millisecond bursts involving about 500 stocks, according to Nanex, a market data firm. The algorithm never executed a single trade, and it abruptly ended at about 10:30 a.m. ET Friday.

{ CNBC | Continue reading }

One of the many consequences of global warming is that it’s now, for the first time, possible to drill under the sea bed of the Arctic ocean. The oil companies are all there, of course, running geological tests and bickering with each other about the potential environmental consequences of an oil spill. But they’re not the only people drilling. Because there’s something even more valuable than oil just waiting to be found under the Arctic.
What is worth so much money that three different consortiums would spend billions of pounds to retrofit icebreakers and send them into some of the coldest and most dangerous waters in the world? The answer, of course, is information.

A couple of days ago, I called a friend in Tokyo, and we had a lovely chat. If he puts something up on Twitter, I can see it immediately. And on the web there are thousands of webcams showing me what’s going on in Japan this very second. It doesn’t look like there’s any great information bottleneck there: anything important which happens in Japan can be, and is, transmitted to the rest of the world in a fraction of a second.

But if you’re a City trader, a fraction of a second is a veritable eternity. Let’s say you want to know the price of a stock on the Tokyo Stock exchange, or the exact number of yen being traded for one dollar. Just like the light from the sun is eight minutes old by the time it reaches us, all that financial information is about 188 milliseconds old by the time it reaches London. That’s zero point one eight eight seconds. And it takes that much time because it has to travel on fiber-optic cables which take a long and circuitous route: they either have to cross the Atlantic, and then the US, and then the Pacific, or else they have to go across Europe, through the Middle East, across the Indian Ocean, and then up through the South China Sea between China and the Philippines.

But! If you can lay an undersea cable across the Arctic, you can save yourself about 5,000 miles, not to mention the risk of routing your information past a lot of political flash points. And when you’re sitting in your office in London and you get that dollar/yen exchange rate from Tokyo, it’s fresh from the oven, comparatively speaking: only 0.168 seconds old. If everybody else is using the old cables and you’re using the new ones, then you have somewhere between 20 milliseconds and 60 milliseconds when you know something they don’t.

Those are periods of time so short that humans can barely notice them. This essay, for instance, is about 900,000 milliseconds long, and it takes me hundreds milliseconds just to say the word “cable”. Which is a word with more than one meaning. To you, it probably means some kind of wire. But to City traders, it means 1.6254, or something very close to that number. Because in the City, “cable” means the pound/dollar exchange rate. And it’s named that after a transatlantic cable which was used to telegraph the exchange-rate information from London to New York as far back as 1858. […]

Obviously, only computer algorithms can make money from an information advantage which is measured in milliseconds. It’s computers which are making the decisions to buy and sell: if they had to wait for a human to sign off on those things, they’d never make any money at all. […] The more obvious problem with exchanges run by computers is that computers don’t have any common sense.

{ Felix Salmon/Reuters | Continue reading }

photo { Edward Weston }

Mr. Arnuk is a professional stockbroker. But suddenly, and improbably, he has emerged as a leading critic of the very market in which he works. He and his business partner, Joseph C. Saluzzi, have become the voice of those plucky souls who try to swim with Wall Street’s sharks without getting devoured. […]

These two men are taking on one of the most powerful forces in finance today: high-frequency trading. H.F.T., as it’s known, is the biggest thing to hit Wall Street in years. On any given day, this lightning-quick, computer-driven form of trading accounts for upward of half of all of the business transacted on the nation’s stock markets. […]

Proponents of high-frequency trading call them embittered relics — quixotic, old-school stockbrokers without the skills to compete in sophisticated, modern markets. And, in a sense, those critics are right: they are throwbacks. Both men say they wish Wall Street could go back to a calmer, simpler time, all the way back to, say, 2004. […]

The two want to require H.F.T. firms to honor the prices they offer for a stock for at least 50 milliseconds — less than a wink of an eye, but eons in high-frequency time. […]

Mr. Arnuk then eyed the stock’s price on dozens of other trading platforms — private ones most people can’t see. Known as the dark pools, they help hedge funds and other big-money players trade in relative secrecy.

Everywhere, different prices kept flickering on the screens. Computers at high-speed trading firms, Mr. Arnuk said, were issuing buy and sell orders and then canceling them almost as fast, testing the market. It can be hell on human brokers. On the tape, the stock’s price was unchanged, but beneath the tape, things were changing all the time. […]

On the afternoon of May 6, 2010, shortly before 3 o’clock, the stock market plummeted. In just 15 minutes, the Dow tumbled 600 points — bringing its loss for the day to nearly 1,000. Then, just as fast, and just as inexplicably, it sprang back nearly 600 points, like a bungee jumper.

It was one of the most harrowing moments in Wall Street history. And for many people outside financial circles, it was the first clue as to just how much new technology was changing the nation’s financial markets. The flash crash, a federal report later concluded, “portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral.” It turned out that a big mutual fund firm had sold an unusually large number of futures contracts, setting off a feedback loop among computers at H.F.T. firms that sent the market into a free fall. […]

Since the 2010 flash crash, mini flash crashes have occurred with surprising regularity in a wide range of individual stocks. Last spring, a computer glitch scuttled the initial public offering of one of the nation’s largest electronic exchanges, BATS, and computer problems at the Nasdaq stock market dogged the I.P.O. of Facebook.

And last month, Knight Capital, a brokerage firm at the center of the nation’s stock market for almost a decade, nearly collapsed after it ran up more than $400 million of losses in minutes, because of errant technology.

{ NY Times | Continue reading }

At least four law suits have been filed as of Wednesday, including one suit by a Maryland investor alleging that Nasdaq OMX Group “badly mishandled” the IPO such that trades were delayed and orders couldn’t be canceled. […]

For example, according to his complaint, Goldberg himself tried to make a series of limit buy orders via an online account. When the trades failed to execute, he tried to cancel them. His cancellation orders were reflected as pending for much of the day, and one trade, to purchase Facebook shares at $41.23, was executed three hours after the order was made, when the stock’s price had dropped to around $38. […]

Meanwhile, three other suits have been lodged against Facebook and numerous financial service firms who underwrote or otherwise took part in the IPO.

For example, Lieff Cabraser Heimann & Bernstein, announced that it had filed a class action lawsuit on behalf of all persons and entities who purchased the securities of Facebook, Inc. in connection with its $16 billion initial public offering of common stock on May 18, 2012 (the “IPO”).

The action was brought against Facebook, some of its officers and directors, and the underwriters of the IPO for violations of the federal securities laws.

Meanwhile, Los Angeles law-firm Glancy Binkow & Goldberg LLP, filed its own class action lawsuit on behalf of investors. The complaint, captioned Lazar v. Facebook, Inc., et al., was filed today in the Superior Court for the State of California, County of San Mateo, on behalf of a class consisting of all persons or entities who purchased the securities of Facebook.. It alleges, among others, that the offering materials provided to potential investors were negligently prepared and failed to disclose material information about Facebook’s business, operations and prospects, in violation of federal securities laws.

{ Securities Technology Monitor | Continue reading }

Fri May 18, 2012 11:44am EDT

“A 15 to 20 percent pop is in the realm of possibility,” said Tim Loughran, a finance professor at the University of Notre Dame, before the start of trade. […]

Some expect shares could rise 30 percent or more on Friday, despite ongoing concerns about Facebook’s long-term money-making potential. An average of Morningstar analyst estimates put the closing price for Facebook shares on Friday at $50.

{ Reuters | Continue reading }

related { Morgan Stanley told brokers on Wednesday it is reviewing every Facebook Inc trade and will make price adjustments for retail customers who paid too much }

photo { Joel Barhamand }

The 50-year-old [David Harding] runs Winton Capital, one of a secretive but influential band of computer-driven hedge funds that bet tens of billions of dollars on the world’s financial markets using algorithms - mathematical instructions to computers - which consume everything from bond price moves to rainfall statistics.

For Harding, whose business attracts mainstream pension investors from the world over, all of human knowledge is relevant. Rivals are circling, and data is becoming an increasingly strategic weapon.

Winton’s collection of funds is now worth more than $29 billion. It has returned 14.8 percent a year in its main fund over the past decade - one of the best records over that period in the UK - and Harding is now likely to be Britain’s highest-paid person, according to this year’s Sunday Times Rich List. It says his wealth almost doubled last year to 800 million pounds ($1.27 billion).

Funds like his are known in the industry as trend-followers, managed futures funds or Commodity Trading Advisors (CTAs). Now run almost entirely by scientists, their ‘black box’ trading has entered popular culture: Robert Harris’s latest thriller, “The Fear Index”, features a fictional physics expert like Harding and rogue computer code.
But as algorithmic hedge funds have become better known and sucked in investors’ money, returns have started to falter. Managed futures funds on average have lost money in two of the past three years, gaining just 4 percent in aggregate while the S&P 500 rose 49 percent.

The funds are struggling to cope with skittish markets. But they’re also being squeezed by a more mundane fact: their basic techniques aren’t so hard to copy, and can be worked out with a few internet searches.

{ Reuters | Continue reading }

Whenever we get a day like today — down more than 500 points on the Dow at one point — my phone begins ringing with inquiries from various media.

They always ask the same question: What should investors be doing NOW?

That is the wrong question. The proper one is: What should investors have done in the past to prepare for an event like TODAY?

The bottom line remains that investing is a proactive — not reactive — endeavor. If you respond to every twitch, every news story, each turn of the wheel, you will become whipsawed.

That is no way to invest. And its no way to live life, stressing out over things that are out of your control.

What you can do is anticipate events that are cyclical in nature. These major shudders repeat every few years, so we should not be surprised by them. Construct a plan that allows you to ride out these events without panic or forced errors. You need a plan that anticipates these regular occurrences.

{ Barry Ritholtz | Continue reading }

Why is it that men so often self-destruct? (…) We men just make bad decisions. We can’t help it. We’re men.

Women, on the other hand, do almost everything better. We’ve known this intuitively for a long time. If you didn’t, just ask your wife or your mother. But now there’s a raft of evidence that suggests women are better at everything — including investing.

A new study by Barclays Capital and Ledbury Research found that women were more likely to make money in the market, mostly because they didn’t take as many risks. They bought and held. Women trade this way because they aren’t as confident — or perhaps as overconfident — as men, the study found.

{ MarketWatch | Continue reading }

photo { Katy Grannan }