On the 25th anniversary of the 1987 stock-market crash, traders are once again trying to find something to believe in. After yesterday’s Google earnings debacle, distrust of China’s GDP data and fears that Europe won’t act forcefully enough to stem problems in Spain and Greece, it's causing a lack of confidence sell-off. Yet while oil toils and precious metals falter the heating oil-gasoline spread continues to rock.
Oil prices were sliding yesterday because the Chinese GDP data was either too strong to inspire quantitative easing or too strong to be believed. Doubts crept in after reports of a big drop in electricity demand. China’s electricity consumption grew at an annual rate of 2.9%, the slowest growth in two years. We had the combination of a strong Philly Fed and reports that the politically charged Trans Canada Keystone Pipeline was shut down for three days for what was being called an “anomaly.
The Chinese National Energy Administration releases a monthly report on electricity consumption. The most recent observation for September showed that electricity consumption grew at an annual rate of 2.9%, the slowest growth in two years. Growth was 3.6% in August and was 11.7% during 2011. According to estimates from Patrick Chovanec, business professor at Tsinghua University, electricity consumption actually fell 9.8% in the month of September, which is considerably weaker than the normal seasonal decline.
Yet with all the wild swings, we continue to see incredible moves as the “Widow-Maker,” long heating oil short RBOB gasoline, spread has picked up over 20¢ in a week. While the spread is rebounding a bit and the volatility is high the spread should continue to work as spread traders may sell into a 7¢ to 10¢ correction.
Beehive Bang Up!
The Wall Street Journal reported that some natural gas traders are complaining because apparently they believe that high frequency traders are "banging the beehive." Banging the beehive the Journal says is when “high-speed traders send a flood of orders in an effort to trigger huge price swings just before the U.S. Energy Information Administration (EIA) storage data hit. Or as I call it “price discovery.”
The Journal writes that veteran natural-gas trader John Woods has a simple trading strategy around data on U.S. gas stockpiles: Stay away. Mr. Woods and other floor traders at the New York Mercantile Exchange used to look forward to the weekly report of gas-inventory figures by the EIA, widely considered the best reading of gas supply and demand in the United States. Traders would be glued to their computers before the release at 10:30 a.m. on Thursdays, ready to dive into the busiest trading window of the week. But in the past few months, unusual trading patterns have pushed many seasoned traders to the sidelines.
The Journal states that the, "shifting landscape in natural gas shows how high-speed traders are changing markets well beyond stocks, which so far has been the primary focus for regulators and lawmakers investigating rapid-fire trading.”
Yet banging the beehive has been around a lot longer than high-frequency trading. In fact it used to be in the domain of floor traders that used to “seek and destroy” stops in a thin market. Obviously if you are a floor trader you are upset that you no longer are the destroyer and now are the hunted.
Yet all of that gamesmanship in the market does serve a valid economic purpose. It is called price discovery. If traders did not trade and move the market from time to time the market would have no value for the users or the producers of the commodity that have longer term price stability in mind. If the traders bid the market up and it falls back down then it is likely based on the move that prices are not supposed to be that high based on the current fundamentals and vice versa the other way around. Yet at times this gamesmanship leads to a large move that sheds light on what might be hidden fundamentals that can send an early warning signal to the buyers or sellers on the underlying market to take cover or take advantage of the underlying changing fundamentals they may save their business from economic ruin.
Besides the added liquidity from the high frequency traders should improve not detract from the markets true function of price discovery and giving the users of the economy an opportunity to hedge their risk that is always there, commodity market or not.
As far as speculators that are afraid of having their beehive banged by the report should not have to not trade the report but just to change your trading strategy.
If you believe that the high frequency traders are going to bang the market, anticipate the move and have them work in you favor and not against you. If you are position trading into a report you have to make sure that if you want to do it right then you have the type of risk capital and tolerance to ride out the wild one hour or one day move. Over the long run if you are right the one day move will not matter. If you can’t afford to ride then you can’t afford to position trade. Or you will have to bite the bullet get stopped out and get back in.
Or better yet use it to your advantage, on report day instead of picking a direction ahead of the report, look to fade the up or down move. If you look at the average moves on report days you should be able to sell on the pop and buy on the drop. Sometimes you should be able to sell close to the high of the reaction and buy near the low. The big swings if executed correctly could give you bigger profits then trying to ride out the bang beehive bang theory. And you should be able to get away with a reasonable stop loss. That way you will have the high frequency traders working for you as opposed to against you. So instead of complaining about the increased liquidity and inevitable improvements that computerized trading will make, you just may start thanking them for helping you make money in the market. Computerized high-frequency trading is not going to go away so you just have to learn to make it work for you not against you.