Algoholics Anonymous

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Your editor’s phone began buzzing this morning shortly before 6am with texts asking us to turn on CNBC. There we saw what you saw: the Dow Jones had its largest-ever intra-day decline since 1987. The index fell nearly 1,000 points and almost ten percent as about $1 trillion in market value briefly got wiped out.

By the end of the day the loss was just under 347 points or 3.2%. And CNBC was reporting that the whole affair was trigged by a trader entering the wrong number on a trade, probably in Procter & Gamble stock, which fell nearly 37% at one point. CNBC said that, “The erroneous trade may have involved E-Mini contracts – stock market index futures contracts that trade on the Chicago Mercantile Exchange’s Globex trading platform. The composition of the E-Mini is similar to the stocks in the S&P 500.”

So maybe it was all just a misunderstanding. But it was a costly one. When computers take over decision making for human beings via program trading, then the catalyst for a given event can be erroneous and still have real world consequences. Program traders use algorithms that trade automatically buy and sell the market based on resistance and support levels determined by models.

Program trading accounted for about 24% of the trading volume every day for the most recent week for which data were kept, according to the NYSE. During the last week in April, that meant nearly 700 million shares a day were trading hands based on algorithms. It’s not hard to see what happened last night.

A featherless biped made a keystroke error on a P&G trade and erased $60 billion from the company’s market cap. The decline in P&G triggered automated sell orders which drove the Dow below 10,000. The very crossing of the Dow below 10,000 most likely triggered a flurry of buy orders. Voila! Chaos!

Well, not chaos. But certainly volatility. And you thought stock prices were determined buy buyers and sellers with live brains deciding the discounted current value of future earnings. Nope.

To us, the big takeaway from yesterday’s US episode is how, in the rush to digest and reprice news and information constantly, the market now appears susceptible to runaway feedback loops that swing prices and trigger buy and sell decisions automatically. This does not seem like an improvement in efficiency. It seems like a systemic vulnerability that could be exploited in the future deliberately to cause mass panic and wealth destruction.

Expect an investigation, although don’t expect anything to change…until next time.

The fact that traders freaked also shows you how uncertain investors now are. Just minutes before CNBC began going bananas over the fall in the Dow, Pimco’s Mohamed El-Erian wrote in a note to customers that the Greek crisis was leading to tighter inter-bank lending in Europe and “going global.”

Specifically, El-Erian said, “The transmission mechanisms for this latest round [of volatility] include disruptions in European inter-bank lines, a flight to quality, and market illiquidity…the Greek crisis tells you is debt and deficits matter… What you see is the system slowly starting to have cascading failures. It’s like a pipe that you need to be free-flowing and it starts to clog, and that’s a concern…This is a shock to the system and it’s going to have an impact on valuation.”

This resurrects the debate from 2008 over whether the GFC (which has morphed into a Sovereign Debt Crisis) is a liquidity crisis, a solvency crisis, a confidence crisis, all of the above, or none of the above. So which is it?

If the impending Greek debt-default isn’t contained, it WILL be a liquidity crisis soon enough. That’s partly what made New York traders so nervous after Europe’s session. In a leveraged world with falling asset values, liquidity issues become solvency issues. And none of that is good for confidence.

The only people we know that are loving this are traders and value investors. For the better part of three months Swarm and Slipstream Trader Murray Dawes has kept his powder dry. Today he’s firing new trades with both barrels. If you’re a punter, this is precisely the time to capture gains from mis-priced assets (those too cheap AND those too expensive).

It is frustrating for small cap and resource investors who are, if they’re being disciplined, getting stopped out of nearly all of the open positions recommended by Kris Sayce and Alex Cowie since the March lows of last years. Most, although not all, of these positions are getting sold at a profit. But it’s a lot of selling. What next?

The sliver lining to corrections and liquidations is that investors who’ve preserved their capital and cash can go shopping. What you want to buy is up to you. But prices (and generally valuations) are a lot more attractive after big falls. Both Alex and Kris may re-enter some of the same resource companies they’ve been forced to issue sell recommendations on this week. We’ll keep you posted.

As for our new project at the Australian Wealth Gameplan, it’s worked out well, although not for exactly the reasons we expected. Yesterday we recorded a 15-minute video analysing the effects of resource super profits tax and the Greek crisis on the Aussie market. China – whose real estate bubble we pegged as the big catalyst for the revaluation of Aussie stocks – was also discussed.

But no one saw a human trading error leading to complexity catastrophe of cascading sell orders on Wall Street happening this week. Not us anyway. But it did. And here we are, with a full-blown sovereign debt crisis in Europe, a manic market in America, and China’s falling stock market and metals prices indicating that its property bubble is deflating – slowly thus far.

That’s our story, anyway. And the plan-two specific investments designed to profit from the fall of the Aussie dollar and resource prices – is working out okay so far. The third thing going up now – volatility – is also tradeable, but a lot riskier. If you want to read more about the big picture gameplan, you can read the full “Exit the Dragon” report here. Until Monday…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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38 Comments on "Algoholics Anonymous"

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debt anstalt
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Public deficits and debt matter – Do they ever! One reason is because of the extent and importance of public services that need to be maintained for community well-being. Debt and deficits can put these at risk. Imagine a scenario where austerity measures are required and large public sector cuts are applied to all parts of the public sector(including to the budgets of the police & riot police). Many communities might respond with strikes/riots where the public servants, including the police, would be involved in the strikes. That is, there are strikes and riots with no-one to contain the chaos.… Read more »
Biker Pete
Guest

GOODNESS! Who ya gonna call? Goldbusters?!~

Roy
Guest

You are a man with a dream BP, who knows what he wants and sticks to it, I admire that even though we don’t see eye to eye.

Unfortunately looks like your view (RBA?) of the Aussie economy is somewhat different to the bond market.

http://www.businessinsider.com/default-fears-soar-for-australian-financials-2010-5

Biker Pete
Guest
Thanks, Roy. To the surprise of many, including myself, we’ve achieved the dream. In this forum I simply represent the view that property investment, managed well, can set you up for an independent, happy retirement. But I also agree with Bill Bonner’s latest gem, probably not published on the Aussie site, yet: “…this is a dangerous market. It is no place for widows, orphans, nuns, priests, republicans, democrats, window-washers, bungee jumpers… ” Or one’s offspring. One of my boys lost around $70K in the last week or so! Gold? I’m ambivilant. Great stuff. Good long term prospect? Not so sure.… Read more »
chris
Guest
When you buy real estate you are buying into a supply of a scarce commodity – land. Its scarcity is why it is an unusual investment. If land failed to appreciate, you would have to be very clever to make money out of real estate. The US subprime mortgage calamity aside, investors can, and do lose money on real estate, even in Australia. Granted, in big cities, you will probably not lose your shirt on property, but recent experiences in smaller towns show that when demand for property disappears, only drastic discounting can find any buyers. I was interested in… Read more »
Trader John
Guest
It wasn’t the machines, terminators or otherwise, that generated the down thrust. One or two might have sold hard into liquidity vacuums on some thin shares, but they were participants not the cause. How can I say that? Because the big discretionary traders in the S&P’s were selling hard into the drop. It was preceded by an attempt at new highs (on the 5m chart) then two lower highs and lows before a near perfect collapse dropping smoothly (algo drops are sharp) through stop level after stop level until finally buy orders overcame sell orders and a (temporary?) recovery took… Read more »
Stillgotshoeson
Guest
Comment by Biker Pete on 8 May 2010: In this forum I simply represent the view that property investment, managed well, can set you up for an independent, happy retirement. I agree.. may surprise you but I agree. Property is and should be a part of a persons investment stratergies and goals. I just belive that there are better buying opportunities in other classes at the moment. Property as “shelter” and not the investment aspect probably does not matter when you buy.. if you are gong to live in it for 30,40, 50 years price paid probably won’t matter.. if… Read more »
Steve
Guest

Biker Pete:
“One of my boys lost around $70K in the last week or so!”

I can hear the flutes playing soft yet soothing music in the background and a tear starting to develop in my eye

Biker Pete
Guest

Most of his money is in property and cash, Steve. His Super holdings alone, at 28, would certainly bring that tear to your eye. :)

Nice line, though. Who wrote it? ;)

Biker Pete
Guest
It’s good that you set a sell when you set a buy, Shoes. It works most of the time. Long term? I think those who haven’t set a sell will be caught holding when the bubble bursts. Yes, we know that all bubbles burst! :) The extent to which property fell in the last three years was only brought home to me last night, when my missus found and showed me the 2007 adverts for our most recent land purchase around a year ago. This block, with water views, all fences and $9K worth of landscaping, was listed at $178K.… Read more »
Steve
Guest

I did I just couldn’t help myself

Biker Pete
Guest

I _rufuse_ to believe it!~

Seriously… you wrote it? I thought you’d probably copied and pasted it from another blog… .

Nice shot, anyway!

Steve
Guest

You see thats the problem with you Biker you refuse to take what people say at face value

You say that I put the thumbs up on my posts and sown on yours which is someone else doing that

now you are doubting my poetic abilities

I WROTE it, I find it humbling that you think its so good that you don’t think I wrote it, But I did, I can’t do or say say anything to prove it to you, but I wrote it

Biker Pete
Guest
No, No… you misunderstand me, Steven. My _job_ is to educate you. The school system totally failed to help you achieve your full potential… and I have been appointed your Failsafe Mentor, to bring you up-to-speed. Look how easy it is. A snap comment and I’ve taught you how to spell ‘refuse’. Everyone has poetry in them, Steve… it sometimes takes a catalyst, a special individual, a lyricist, to bring out that hidden talent. No need to say thanks. Just go back and look. I _immediately_ gave you five stars and a Thumbs Up. You’ve come light years since you… Read more »
Steve
Guest

Yes Biker well I do live in South Western Sydney and was only educated at a public school so I am doing ok and even better now that you have appointed yourself as my Failsafe Mentor which has helped my potential greatly!!!
I appreciate your support and willingness to further my education and help me to realise my full potential.

(is this the part where I get down on my knees and bow down to you?)

Biker Pete
Guest

Not at all necessary, mate. Nothing wrong with most public schools, either!~
I figure some schools just give up on us when they should persist a little more. It’s too easy to write-off a noisy individual when sometimes a friendly nudge in the right direction is all that’s needed… . :)

Tim
Guest

Just reading an article on the budget, and say this line

“Our deficit and our debt would have been far higher if we had not chosen to stimulate the economy as we did”

seriously? this man is doing our budget? By that logic we should all go out and max out our credit cards we would be in much less debt that way right?

http://www.abc.net.au/news/stories/2010/05/09/2894216.htm

Webby
Guest

That’s nothing.
My dog lost $94k last week!

Steve
Guest
Biker Pete
Guest

Plan to pay _cash_ for a house, do ya, Steve?~

Steve
Guest

Where did I say that Biker Pete?

Lachlan
Guest

“Our deficit and our debt would have been far higher if we had not chosen to stimulate the economy as we did”
Seems students of economics are spending years to come up with brilliant theories such as this…like infinite borrowing/spending is the key to wealth creation…pay off debt with more debt etc etc. After all it helped Greece become the centre of prosperity it is. Even a mum with a household budget intuitively knows better. Yep, the world has gone mad.

Biker Pete
Guest
Well, let’s see. You’re poised to grab a bargain when Sydney house prices collapse, right? Unless you have a few hundred thou put away, you’ll be borrowing… right into a rising interest market. We both know your current wage… and if Shoes’ estimate is right, you may find it a tad difficult to service a loan at 10% or higher. Have you done your sums? Just how much _can_ you afford to borrow… and repay? My guess is that this will be the first time you’ve borrowed (and that’s not a bad thing)… but how much mortgage stress could you… Read more »
Biker Pete
Guest
I agree, Lachlan. Pay _cash_ whenever you can. Sometimes, though, when that special opportunity presents, borrowing isn’t too bad a choice. In fact, it may well be the only way one can sieze the opportunity of a lifetime. Sadly, that’s sometimes at someone else’s expense. The ’87 share market crash gave us that chance, to buy a property now worth eight times what we paid. The owner lost bigtime and in less than three years _had_ to sell. He accepted our opening offer (exactly $100K less than we were prepared to pay). We borrowed, repaid the debt quickly… and have… Read more »
Steve
Guest

WRONG biker I never said that

When rates rise property values fall usually

thats why I want higher rates, I have $133 000 in the bank I am not going to buy a mansion I still only intend to buy a unit/townhouse 1/2 bedrooms in an outter suburb.
So interest rates of 10% arent really going to hurt me that much

But people who had no deposit or very little deposit it will hurt them
So thats why rate rises are good

Lachlan
Guest
Sounds good Biker. You speak as an animal of the system, maybe a system now changing but you created your wealth by mastering that system. I did very well borrowing for property but ten years ago and through more luck than anything. I was not looking for investment just a diehard with a small nursery business that I was totally absorbed in. I had very ridgid requirements for my block and spent years looking for the right one. Ended up with three totally cleared, useable acres with unlimited water, (low salts, acceptable pH, bicarb etc), single and 3phase power, just… Read more »
Biker Pete
Guest

Good luck with that, Steve. Seems like a reasonable plan to me. All you need to do now is continue to save… and await The Crash.

Lachlan
Guest

Oh. I was forced to sell that property as I may have said once.. but life goes on and new opportunities keep a comin :)

Biker Pete
Guest
Wasn’t a great share trader in the five years I worked at it, Lachlan. I had broken my leg in three places, was laid up for four months… and a mate challenged me to tackle the stockmarket. I survived (thrived!) even when the dotcom crash hit, but was taken out eighteen months later when I became a little overconfident. I made an almost identical amount in that five-year-execise as did my accountant. We both agreed, after that, to stick to property!!~ Talked to our eldest tonight. He’s not at all worried by the global shenanigans. Have to confess that I… Read more »
Biker Pete
Guest
Just realised you picked up that gem for $35K(!) Lachlan. Didn’t register at first. Think I read it as $350K. Pretty amazing. Haven’t heard anything like it in the last three decades in WA. As you say, opportunities still present from time-to-time. We’d agree you really have to research continuously to find them, though… My missus showed me a brand-new three bedroom, double-garage home for $300K, today. We’ve just signed up for a new project, so we have our hands pretty full at present (until we pull our Super) but someone who moves quickly is about to pick up a… Read more »
Lachlan
Guest
Yep it was the biggest fluke Biker. It was one of several blocks being sold off at a discount (property was dead quiet..not so a week later) by a vendor who received them in a court settlement and who wanted cash fast. Youd need 250 to buy it (in bare state) now but theres nothing like it left in the district anyhow. Lucky lucky lucky. To pick up that in such a beautiful place too one week before a boom. Even when we bought it there was an identical block above it which had sold for 48 several years earlier… Read more »
Lachlan
Guest

Yeha Biker. Just checked the AUD is strongly headed up to 90. If we can get 93.5 she’ll be looking bullish again…I’m not prepared for a crash yet :(

Ross
Guest
Lachlan, I will be out by tommorrow of ASX index positions. I’ve been continuous on ASX since May 08 and resisted doomsaying til now. On stocks, took profit on my best 10% by Jan, and then resources a month ago. Now holding only onto high NTA soft commodities, engineering services with a forex earning base, and a long Caltex that might end up nationalised (thats what all Bernie Fraser’s industry funds are for isn’t it?) at a price made right for Chevron by US government intervention. Hope any here that caught the NZD-AUD cross long wave are now thinking of… Read more »
Justin
Guest

That all sounds great Lachlan. Just remember if you count your wealth in dollars you’ll wind up fleeced.

The recent gyrations in the ‘money markets’ should be enough to convince even ‘platinum’ Pete.

Don
Guest

I love it when they talk about “loaning” money to Greece. I thought the definition of a loan was that one day you get your principle back :)

Biker Pete
Guest

“The recent gyrations in the ‘money markets’ should be enough to convince even ‘platinum’ Pete.”

I was convinced years ago, Justin. These days I stick with what I know; the stuff that pays fortnightly dividends… and sends us two more salaries every August. Younger blokes with more recovery time are happier in higher risk territory. As they say, there are no old bold riders… . ;)

Lachlan
Guest
I thought we’d hear from you at this time Ross. I dont blame you selling out. My first thought about this was a shake out and move higher since this strategy is played out continuously. Ross I cant keep up with the fundamental as you do however on Sunday I looked at all the info I could read and I just cant see how the sovereign dominos can stay up for many more months. My theory is we’ll see some desperate money printing/monetisation soon amidst a crash scenario. The currencies are finished surely..well at least who has a credible way… Read more »
Biker Pete
Guest

Go for it, Lachlan!
Cheers,
BP

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