Lecture 8 (no lecture 7) Flashcards
What is market making?
It is an activity where a firm’s trader stands ready to buy and sell
What do market makers need to do/exercise in order to balance their inventory of holdings in these stocks?
Exercise judgement
What is HFT? (give 4 characteristics)
HFT is a type of trading using computer algorithms to rapidly trade securities
1) HFT is characterized by high speeds, high turnover rates and high order-to-trade ratios
2) HFT uses market making and trading strategies carried out by computers to move in and out of their position in milliseconds
3) The high volume and high speeds aims to capture as small as cents in profit on every trade using significant amounts of capital
4) HFT can achieve potentially ten times higher sharpe ratios than traditional buy-and-hold strategies
How do HFT firms perform “market making” activities?
HFT firms use a set of high frequency trading strategies that involve placing a limit order to sell (or offer) or a buy limit order (or bid) in order to earn the bid-ask spread.
What may happen to HFT in extreme volatility
The HFT firm has no obligation to maintain this activity during periods of extreme volatility
What are the 4 impacts of HFT
1) Liquidity
2) Volatility
3) Price discovery
4) Market confidence
What is Liquidity in the 4 impacts of HFT
An increase in liquidity has come from HFT which has led to a reduction in bid-ask spreads
When may trading volume and narrower bid-ask spreads NOT be a reliable indicator of liquidity
During times of significant market volatility
What is Volatility in the 4 impacts of HFT
Volatility can be increased by more aggressive HFT strategies
What is “front running”
It is an illegal practice of having knowledge of your client’s order and executing your own orders first
What is Price Discovery in the 4 impacts of HFT
HFT is good for pricing in short term but not in long term
What is Market Confidence in the 4 impacts of HFT
Market participants may lose confidence in the overall market since they may think it is a rigged system, with HFT having an edge at the expense of investors
What are the 3 things that can be done about HFT
1) Good
2) harmful
3) very harmful
What is “good” in things to do about HFT
HFT has made markets more liquid and decreased transaction costs
What is “harmful” in things to do about HFT
Traders who post standing limit orders that cannot reflect changes in value due to news changes fast enough and lose HFT
What is “very harmful” in things to do about HFT
HFT traders front run traders who are working larger orders, making their trades more expensive
How do HFT firms make their profits/ranges? How do they get an edge over other investors?
HFT firms use faster computers, locating servers closer to exchanges, using algorithmic code, employing many types of orders and paying high speed data feeds and dark pool access and being faster by milliseconds
What needs to be done to fast HFT’s to help out slower ones? What is the risk to these slower HTF’s
The market needs to be slowed down because the fast HFTwill make the slower ones go out of business, allowing for less competition. Less competition will make only a few firms in business increase spreads and increase transaction costs for all participants
What risk does algorithmic trading by HFT pose?
It poses systematic market risks
What are dark pools
Private exhanges not accessible to the public, usually owned by broker-dealer
What does cycle analysis attempt?
attempts to find recurring major and minor peaks and throughs in price movement for better trade timing
How can actual price be forecasted in cycle analysis
By adding short, medium and long term cycles together
What are cycles like in trading ranges?
cycles are fairly regular in that the market peaks half way through the cycle
What are cycles like in trending markets
cycle peak tends to shift left or right depending on the direction of the larger trend (called left or right translation)
What should prices do in rising markets?
Prices should spend more time going up
What should prices do in falling markets
Prices should spend more time going down
How do we define one cycle?
Price movement from a local bottom to a local top and then back to the bottom
What are the 2 arguments against the cycle concept
1) If prices behave in pure cycles, then it should be easy to make a formula that could predict and forecast, but this isn’t the case
2) it has yet be discovered the causes of specific cyles that many agree do exist in prices
What are the 3 qualities of a cycle?
1) amplitude
2) period
3) phase
What is amplitude in a cycle
It measures the height of a wave from a peak to through signifying the strength of the cycle
What is a period in a cycle
It’s the time a wave spent between throughs
What is a phase in a cycle
It is a measure of the time location of a wave through. (i.e: the difference in time between throughs of different waves)
How are cycles measured?
Measured from through to through as the tops tend to take more time to develop
What are the 4 important principles to cycles
1) summation
2) harmonicity
3) synchronicity
4) proportionality
What is summation
all price movement is a simple addition of all active cycles
What is harmonicity
Means that there are waves within waves and that they are usually related
What is synchoricity
refers to the tendency for waves of differing lengths to bottom at the same time
What is prortionality
describes the relationship between cycle periods and amplitude
-longer cycles should have greater amplitude
How long should cycles be? give an example
Cycles tend to have period lengths a multiple of 2 or 3 longer or shorter than the next larger or smaller cycle
Ex: a 9 month cycle, the next shorter cycle will probably be 4.5 months (1/2 of 9) & the next longer cycle will probably be 18 months (2*9)
What does nominality state?
Trend tends to be a nominal set of harmonically related cycles that affect all markets
What does translation state
The reason we study lows in cycle analysis is because longer and shorter cycles tend to be synchronized at their lows. However, peaks are almost never synchronized
When should peaks occur in the cycle?
Peaks should/tend to occur at the halfway period of the cycle but peaks can occur earlier or later than the halfway point
If the peak is away from the centre, what is it called?
It is called the translation, there is a right and left transaltion
Describe right translation
When the peak is beyond/AFTER the halfway point
-if the trend is up, the cycle is said to translate to the right
If the peak occurs at the halfway point, what would we question?
We would be suspicious about the continuation of the uptrend
Describe left translation
when the cycle peak occurs BEFORE the halfway point
-f the trend is down (downtrend/bearish) the cycle is said to transalte to the left
What is translation useful for?
See where longer term cycle is headed or if it is changing
Finish the phrase: As cycles are nested and synchronous…
… the shorter the cycle is dominated by the trend of the next longer cycle
When does an inversion occur
when a peak occurs where a cycle low is expected
What is kondratieff waves (k-waves)?
They are economic phenomenas that are not necessarily observable in commodity and stock prices. The theory that western capitalist economies have 50-60 year boom periods followed by a bust
What are the 4 seasonal periods that each wave is broken down into in k-waves
Winter
Spring
Summer
Autumn
What is Winter in k-waves
a period of concern, fear, panic, depression
What is Spring in k-waves
a period of fear of depression, fragile confidence
What is summer in k-waves
a period of growing confidence
How does each wave in k-waves arise
arises from bunching of innovations in product, services, technology, methods of production new markets, new sources of raw materials, and new forms of business organization
What is Autumn in k-waves
a period of increasing confidence, that turns into extreme confidence and euphoria (happiness)
What does the 34 year historical cycles suggest
Suggests that 34 year cycles, composed of 17 year period of dormancy followed by a 17 year period of intensity, also appear to exist
-This is a period when TA outperforms FA (trading versus buy and hold)
What are decennial patterns? (give 4 characteristics)
1) are made up of ten 12-month periods and three 40-month cycles, coinciding every 10 years
2) this pattern states that years ending in 3,7,10 and sometimes 6 are often down years in the market
3) Years ending in 2,5,8 and most of 9 are advancing years
4) this theory is to keep in the back of your mind but not something to use alone to commit funds to the stock market
What is the four year cycle?
From price floor to price bottom, is the most widely accepted and most easily recognized cycle in the stock market
What is the election year pattern? (give 3 characteristics)
1) Stock market returns can be related as a function fo the US presidential electoral timeline
2) Equity markets are WEAK during POST election & MID year (yr1& 2)
3) Equity markets are STRONG during MID year 3 and PRE election (yr4)
Why do election patterns tend to happen?
Administrations trying to sway voters with good economic policies and favourable interest rates which in turn would stimulate the economy, and favour them in getting re-elected
Where are seasonal patterns mostly seen?
agricultural prices and commodities
What does seasonal trends allow investors to do?
Allows investors to profit from certain price trends that occur year after year,
What months are the worst for the stock market?
August and september
What are the best months for the stock market?
October, November and January
What may attempt to explain the worst and best months of the stock market
Most fund managers establish their targets at the beginnning of their fiscal year (Oct or Nov) and once they attain their targets (usally by May) they tend to back off of their trading, as their targets have been met
What is the January barometer
states “as the S&P goes in January, so goes the year”. Meaning that an up in January will foreshow a year of positive equity returns and vice-versa
What is the January effect
states that small cap equities tend to outperform the broader market in the first few days of the new trading year due to investors buying back stocks that were sold for tax loss reasons at the end of the previous fiscal year
If a portfolio manager wishes to sell many shares of a stock, what is an advantage of using dark pools to do so?
It would lower the impact on price of the shares they are about to sell
