Knight Capital Group is one of the large trader with $1.4 Billion of revenue last year. Per the profile here:
Knight Capital Group, Inc. is a global financial services firm, which provides access to the capital markets across multiple asset classes to a broad network of clients, including buy and sell side firms, dealers, brokers, institutions, and corporations. It operates business through four segments: Market Making, Institutional Sales and Trading, Electronic Execution Services and Corporate and Other
So Knight is not a ‘fly by night’ ;-)
Yesterday August 1, they decided to turn loose an automated trading platform. ( I don’t know if this was an ‘upgrade’ to an existing platform or a new venture). It “had issues”. How much of an issue? They did 20 weeks of trading in 45 minutes (so perhaps someone set a time parameter wrong…) In 45 minutes of automated trading it lost about $440 Million. In comparison, it made about 1/4 of that in each of the last 4 years. So 4 years of total earnings, flushed in 45 minutes.
It caused a large number of stocks to plunge, and another group to shoot up, just from the artificially high volume being created by this one trading program “gone wild”. The volume spikes and price swings caused the Talking Heads on the financial programs to comment at the time that something was up. In the days since, the news has been about the nature of the fault and the likely result.
Today it has the CEO using those words like ‘strategic options’ and ‘seeking financing’ and ‘exploring options’. All mean “get the hell out if you are not already”. Citybank has issued direction to NOT route orders through them. Others will be doing the same. They are most likely “toast”. I would expect a “buy out” by someone who just wants the customers, assets, and some of the staff. (Clearly not the automated trading guys…)
So how would you know to “get out”? First off, behind any and all positions you ought to have a “stop loss order” that automatically executes if things are just “crazy wrong”. For active trading, using a 5% stop loss is common. For investors, a 10$ band. If you are watching things (daily or weekly) you can adjust these down if you see a ‘dip’ where you don’t want to sell, but want to add to a position. They are there to get you out when you are NOT watching and adjusting them…
But when you ARE watching, how do you know to exit a stock if the “news flow” isn’t saying anything?
Lets look at the 10 Day chart. In this case, with 15 minute price bars.
I’ve added to this chart a “volume by price” indicator up top. Each lateral red bar from the left margin is an indication of the total volume trading at that price in the entire 10 days.
Notice that price was relatively flat for 8 days. The first three ‘volume by price’ bars are fairly small (compared to the rest) and cover all that volume over all those days. Then, yesterday, the fall started. Initially it will have been part of the general trading disruption it was causing with the bogus machine trades. Then the news will have spread (via rumors at first) to the trading desks that KCG was the cause. That’s when you see the volume really pick up as the price drops. Some folks dumping long positions, some “stop loss” orders being hit (eventually enough to swamp the ‘buy if touched’ orders as they are being withdrawn by some parties). As the news goes public, the volume picks up even more as the price plunges.
The next day, once even more folks have ‘heard the news’ and know how bad it is, the stock opens “gap down” hard. Then the fall continues… At this point, down 62% today.
So when was the “right time” to get out? Frankly, ANY time is the right time. The sooner the better. A 10% (or even a 20%) stop loss order would have been a very welcome thing in retrospect. ALWAYS take an early loss. ( “The first loss is the best loss” is an old market aphorism.)
Would our ‘indicators’ have helped? Yes. Notice that RSI had a ‘near 80′ peak with a ‘lower high’ on Monday ( 4 days ago) and was saying “be out soon” even on a fast swing trade basis. MACD (though hard to see due to how large it becomes in the last two days) was ‘red on top’ and slope headed down three days ago (Tuesday) so saying ‘get out now’. Anytime Wednesday the MACD was
below zero and headed down hard. Shouting “Get Out Now”. The Black ADX line was above 25 (so strong trend) and had DMI- (the red line) cross over to on top last Tuesday, confirming the “be out” call.
Realize none of these are predicting the disaster that happened, they are just saying “time to be out” based on the preceding price action. Once the plunge started, they would have turned highly negative even if they had been saying “buy” before the event. Basically, they would have been telling you “take the first loss now.”
But what if you are not a swing trader and only looked at the daily charts? (Remember that you can click on the charts to get a much cleaner more readable version):
You would have been out last March… That’s when MACD crosses below zero and is headed down fairly hard, or even Jan / Feb when MACD first goes to “Red On Top” and RSI is dropping from a high point. DMI/ADX are slower to react on this scale, so we look more at ‘inflections’ and expect crossovers to be confirming not predictive. Even here DMI+ (blue line) has inflected to a downward slope in February and ADX is dropping to ‘low trend’ at 15 saying “the run up is ended – shift to swing trades.” Later it goes to DMI- (red line) on top saying “Short or be out is the bias”. The last favorable ‘swing trade’ to the long side was in April. After that the trades are most productive to the downside as price is clearly below the SMA (Simple Moving Average) stack, MACD is below zero, and DMI is “red on top”. Odds are that trading on this time scale you would already have been short this stock and have made a bundle…
Here is a longer view, a 2 year daily chart:
Looking at an even longer time scale (long term investors, checking positions weekly):
On this time scale, you would have exited any position back in 2006/7 or 2009 (depending on your activity and when entered or reentered) as that was when RSI had ‘lower highs’ while price cut through the SMA stack and MACD went to ‘red on top and falling’. There were a couple of swing trade opportunities (as folks could move to faster charts for them) but sitting out is the style at the typical person using this time scale. DMI- has red on top saying “just stay out” most of the time since then. Even the DMI+ ‘blue on top’ of early this year (with MACD ‘blue on top’ and above zero) was in the context of an ADX line below 25, so saying “faster swing trade – move to daily interval chart”. So investors would stay out.
Does any of this mean it would save you from a fault like this?
Mostly it is the 10 day chart that would save you (if a company that was doing great had such a fault). The longer time scale charts were not predictive of this kind of fault. However… Companies that are “doing great” are usually doing it for a reason. Companies that are “having issues” are usually “having issues” in many areas. So simply being out of a company that was “having issues” avoids proximity risks.
Yes, it takes time. Yes it’s a PITA to do charts all day. I get tired of it. When I’m ‘taking time off’ I’ll put stop loss orders in place behind large positions. Or I’ll just move to cash.
The simple fact is that, due to companies like KCG doing “high frequency algorithmic trading” it just isn’t safe for the small guy to do “buy and hope” investing. In this case it killed them. Sometimes it kills the rest of us. (Anyone remember the “flash crash” where HFT drove the whole market down 900 points in hours?) Even being in things like “index funds” doesn’t escape that kind of thing.
So what can you do? Well, part of it is to use “index funds”. Holding SPY or even XLF (financial fund) would have avoided this “company specific risk” while getting more stable and predictable movements (better behaved with the indicators) and less ability for a single trader to ‘move the stock’. Then having “stop loss orders” in place and paying attention to your positions at least once a day (about 2 hours into market open is a good time, or at least an hour before the close).
It is this kind of ‘action’ that has caused me to move from “value investor” to “hedge fund” in my style. The removal of the “uptick rule” for shorting lets companies do the “long / short” trades that are most often used for this kind of HFT more easily. (No worries about shorting whatever you want to short). Moving to decimalization lets folks do trades on a single penny of range (instead of 1/4 or 1/8 dollar spreads) so increases frequency. In short, most of the changes of the last decade have encouraged this style of trading (which is no surprise since these kinds of companies where asking for those changes…)
The other thing you can do is to diversify across more market segments. Not just US stocks. Add in some bonds, metals, other commodities, REITS. Then even a HFT in SPY will not jiggle your whole boat. At this time, about 75%+ of ALL trades are computer generated. It’s just crazy. The stock market has largely just become an automated casino with dueling computer programs and some investors doing “duck and cover” every so often when one of them blows up.
Oh well… As they say: “Sure the game is rigged, but it’s the only game in town!”…
But by using some charts, paying attention every day (or two) to your positions, and using some stop loss orders, it’s survivable. Sometimes you can even make a bit of money…