Today offered a great example of how amateurs, either through panic or what they’re taught, often do the wrong thing. This chart to the left is roughly the first 15 minutes of play this morning in the S&P 500 cash index derivative market (SPX). Rather than opening at much of a gap down it opened and immediately bled off about 8 points in the first three minutes. Those bars are 3-minute bars, red is down, white is up.
Now, what we have to the right is the last 15 minutes of play, yesterday, in the S&P e-mini futures market for the September contract, which is currently the "front month" contract. It’s a little complex, but essentially the big institutions have computer setups with very complex algorithms that will buy or sell proportional blocks of all the S&P 500 stocks in a way that sort of tracks the futures, up or down. Essentially, they roughly mirror each other. The thing is, the stock buying and selling stops trading at 4 p.m. EST. Futures trade 24 hours a day, from Sunday at 6 p.m. EST to (I think) 6 p.m. EST on Friday. However, the "normal trading day" for both options and futures goes to 4:15 p.m. each day (volume on the futures goes to a trickle after that, normally, but is always there if needed). So, the point is that what happened in the 15 minutes after stocks stopped trading yesterday was essentially mirrored right at open this morning. It’s the closest thing to a sure bet I know of. So how do you take advantage of it?
The trick is in recognizing that the published close of the stock market index (SPX) is based on the 4 p.m. closing prices of all the stocks and the published "close" of the futures is 4:15 p.m. Normally there’s no action in the futures in that 15 minutes so people have a relative idea of the difference between the cash and futures market, and then if they check after market and pre-market numbers and see that the futures are up or down, they form opinions accordingly. But what when there’s a 7-point down already built in by virtue of that 15 minutes of trading? If you haven’t taken stock of that you could be in for a surprise at the open.
And a surprise at the open that sends the index down 8, and which also breaks through the most recent low by a few points can induce a bit of panic selling. Then traders who had stop orders in place — as they are taught to do — will get their stops hit, executing even more sell orders.
But in this case, the pros were right there waiting to take the other side of those sell orders, so once again the little guys take the loss and the big guys accumulate more shares at the very bottom of a dip. Here’ what the rest of the day has looked like, from 6:45 on, 5-minute bars up until about 11:30. Standard Elliot Wave stuff (works well in the short term, not always; never count on it long term). It’s now 12:15 and we’ve advanced another point.
Recently, a trader who I pay some attention to commented that "nobody ever made money selling in a panic," and I think there’s a lot of truth to that. After thinking about that a good while, I realized that most panic sell offs are great buying opportunities, while the place to sell is when you see panic "tulip-mania" style buying, kind of like in 1999 and 2000. You’re almost never going to time it perfectly and for those who do it’s total luck and chance. It is enough to get close.
As an aside, I think that those with a bearish disposition have a tendency to interpret price inflation (money supply expansion, i.e., printing money) as tulip-mania buying; so they’re always warning about the coming crash. Well, inflation and the liquidity it provides — for better or worse (and I’d say worse) — is, I believe, the primary factor in why we have not had 1907 and 1929 crashes in so long. I’ve got a post on that and perhaps those who know more about the dismal science can correct me if I’m wrong, or elaborate if I’m right or partly right.