Are The Markets Really Broken?

Article first published as Are The Markets Really Broken? on Technorati.

Yesterday morning, MarketWatch.com (a member of the Wall Street Journal digital network) published an article accusing computerized program trading of "breaking" the markets. In it, David Weidner writes, "What the flash crash tells us is that it doesn't take much to make the whole thing go haywire." Using the advent of decimal pricing as the beginning of program trading, however, it would seem that Weidner's logic is flawed.

It is incredible that there has only been one flash crash since the beginning of decimal pricing (in 2001) if program trading has made the markets as precarious as Weidner believes. Furthermore, most of the damage caused by the flash crash was reversed by the SEC in the time between market close May 6 and market open May 7. I contend that computerized program trading has little effect on the "small guy" investor as opponents suggest, and that it actually helps the health of the markets.

An important distinction to make is one between trading and investing. The behavior of the big players on Wall Street is trading. Specific securities are held for periods ranging from seconds to hours, and minute discrepancies between options, equities, and futures prices are exploited almost instantly. To make a profit from this type of market behavior takes an incredible amount of money. These frequent large trades cause high intra-day volatility compared to the pre-computerized trading era.

Investing is what the majority of Americans take part in. The mutual funds in retirement funds, stocks managed as a hobby or an attempt to beat the bank's interest rate, and options received as bonuses from corporations are handled as investments. They are usually held for weeks at minimum, and usually for years or even decades (options are often held to maturity). Intra-day volatility has no effect on these investments, and the "small guy" does not take note of it. Most Americans would not have even heard about the flash crash had the media not seized upon it as an example of Wall Street's greed and arrogance.

In conclusion, the traders of Wall Street circulate large sums of cash via computerized trading, thus stimulating markets. The algorithms automatically correct market discrepancies, thereby stabilizing the markets. The intra-day volatility this causes has little or no effect on the average investor except that as the markets grow, the companies that the investors work for grow as well.  As these are the companies investors hold stock in, both traders and investors benefit from computerized trading.

Politics and the Economy

Believe it or not, there is already intense speculation occurring about the 2012 presidential election, with Republicans trying to capitalize on recent anti-Democratic sentiment and the Tea Party in full swing.  While much could be said about the various Republican hopefuls and their chances, it is interesting to observe the effect all the political talk has on the market.

The most obvious immediate consequence is that the media has temporarily forgotten about the economy, focusing instead on Obama's religious preferences, the viability of Newt Gingrich as a presidential candidate, and  football.  Though the recession is "officially over," several prominent economists still predict a double-dip, and depending on Obama's next economic actions, this economist may agree.  If Obama carries through with his promise to provide even more stimulus, look for investors to keep driving up the price of gold.  Also, look for a short-term spike as with the funds will likely come government-sponsored good-news and a bright outlook.

Long-term gains might be available in the transportation and civil engineering sectors as Obama promises to dedicate more funds to infrastructure, especially highways.  Elsewhere, look for the volatility we have become used to.

Enough of the fluff; what securities are on the rational investor's radar?  In the past month, I've held my position in Devon Energy Corporation (DVN), and suffered close to 10% losses because of it.  However, I maintain that DVN is in for large growth over the coming months.  Buying this stock any time over the next couple of weeks would be beneficial to the mid-range portfolio.  I have also held Dynamex (DDMX) for the past month, which has resulted in a recent 9% gain.

The most recent addition to my portfolio is Healthways, Inc (HWAY), which has an excellent potential for mid-range (2-3 month) growth as it has a low P/E ratio, Beta of 1.54, and analysts estimate 30% gains over the next year.  Wait for this stock to retract its recent gains a bit before buying, but keep it on your watchlist.

The rational investor has indeed returned, and will write more frequent articles over the coming weeks.

Fibonacci Analysis

Article first published as Fibonacci Analysis of Securities on Technorati.


As a student of economics and quantitative finance, I enjoy reading about the different mathematical tools that are used to optimize portfolios.  Most of these algorithms and formulas require advanced and sometimes obscure mathematics, but one simple tool, used by many to calculate optimal entry and exit points for positions requires only simple elementary school arithmetic.  This method is called Fibonacci Analysis, and is as criticized by opponents as it is lauded by proponents.  Without taking a side on the debate, what follows is the basic method of Fibonacci Analysis.

1. Choose a security.  Fibonacci Analysis works best on securities that are traded in large volumes.  The reasons for this should be apparent as you read on.

2. Choose a date range to work with.  Most analysts pick a range from the past three days to a week.

3. Find the high and low prices over the range.  If working in Excel, you would have three columns now: Security, High, and Low.

4. Calculate the change.  Find the difference between high and low.  Put this in your third column of Excel.

5. Calculate the Fibonacci percentages of the change.  This is where the Fibonacci part comes in.  The percentages come from the percentage differences between consecutive numbers in the Fibonacci sequence (1,1,2,3,5,8,13,21,34,55,89...).  The most commonly used percentages are 23.6%, 38.2%, 50%, 61.8%, 100% and 161.8% ((34-21)/55, (34-21)/34, (34-21)/21, etc).  Take these percentages and multiply them by the change (found in step 4), then add to the low price.  You would now have six more columns in your spreadsheet if you used the example percentages.


6. Pick an entry/exit point.  The prices you calculated in step 5 show possible resistance and support points.  Look at the current price of the security, find the closest points, and watch the price's behavior around those points.  If it gains up to a point and then descends, it is probably a resistance point.  If it falls and then bounces back from a point, it is probably a support point.  Therefore, you should not immediately enter stop/limit orders based on these points, but rather watch the behavior as the security reaches these points, and decide yourself whether to buy or sell.


7. Remember that past performance does not guarantee future results.  You may see many examples of Fibonacci Analysis perfectly calculating resistance and support points.  Remember that these examples come from the past, and hindsight is always perfect.  The present is not always so perfect, and anything from earnings reports, news story, or just the general randomness of the market can foil even the most well-calculated Fibonacci Analysis.


The rational investor wanting to read more about Fibonacci Analysis may wish to consult this article.

Stocks to Watch for Wednesday July 21

Earnings season is in full swing, and several high-profile companies are reporting their second quarter earnings tomorrow.  Among the list, including Coca-Cola (NYSE:KO) and Morgan Stanley (NYSE:MS), is Starbucks (NASDAQ:SBUX).  Analysts expect earnings of $0.28 per share, which would signal a successful path of recovery for a company that had overexpanded, brought back its founder as CEO, and turned more towards community and service from corporatism.  In addition to this good sentiment, UBS maintains a buy rating on the stock, and it has a target price of $31.00, which would represent a gain of more than 20% from Tuesday's closing price.  For this reason, I would advise the intelligent investor of the short or long term to add this stock to his portfolio.  It will likely prove prudent at tomorrow's close, and in the months to come.

Volatile Times

It has been several weeks since my last post due to personal business, yet the market is at about the same point as it was when I last posted.  The DJIA seems magnetically attracted to a number between ten and twelve thousand, so the seasoned (and lucky) day trader can make large sums of money on the intra-day volatility as well as the periodic swings the market has experienced.  As I mentioned in my first posts, Harvest Natural Resources (NASDAQ:HNR) regularly swings between around $8.00 and $9.00, usually within about week's period.  Adding this stock to your portfolio around $8.00 is prudent for nearly any investing strategy, but I would not advise short-selling this stock any time soon.  Other analysts have given this stock a price target of $12 which would mean a 48% gain from today's close.

I also recommended watching DVN several weeks ago.  It has lost over 7% from that date with little change in circumstances and so is looking more attractive than ever.  However, it is risky to buy this security now, as it could easily fall further for scant reasons.

With Obama planning to sign the financial overhaul bill later this week, the markets should remain volatile for the foreseeable future.  I will cover the long-term implications of this bill's passage later this week.

Google purchases ITA Software

In what may be its largest acquisition of the year, Google announced yesterday that it bought ITA Software, an air travel service, for $700 million. According to their own report (link), the decision will not affect existing deals for ITA, though Google is "enthusiastic about adding new partners."

Google continues to expand into new and random markets, building an internet empire funded almost entirely by advertising. Since 2001, the company has acquired more than 70 companies, though ITA appears to be one of its larger investments. ITA is a relatively stable company with a high-profile list of clients including United Airlines, American Airlines, Continental Airlines, Orbitz and Hotwire. I would imagine this deal will be extremely beneficial to Google, and I look forward to healthy effects on its already-undervalued share prices.

Immigration Reform Another Grasp for Stability from Obama

Article first published as Immigration Reform Another Grasp for Stability from Obama on Technorati.

Today, July 1, Obama brought one of the key campaign issues of 2008: immigration reform. Taking a shot at Arizona's controversial new law (which will take effect at the end of this month), he said "These laws also have the potential to violate the rights of innocent American citizens and legal residents." This change of priorities for the president comes on a day which saw a nearly 300 point swing in the Dow Jones Industrial Average, and may be an attempt to secure certainty in at least one area as the mid-term elections approach.

Certainty has been a hobgoblin for Obama. Entering into his presidency with the clear and simple goal of closing Guantanamo Bay detention camp, his administration has had trouble closing the deal, facing such problems as where to relocate prisoners. Many of the problems with an instant closure are detailed here.

Then, healthcare reform took center stage, and, though the Democrats had a majority in both houses, congress had difficulty passing what is now colloquially referred to as "Obamacare," extending the congressional debates into the Christmas recess. Though it was finally passed and signed into law, Obama gave many concessions, and its full implementation is still uncertain. Perhaps most concerning is its unknown effect on the economy.

Throughout his presidency, the economy has been in the public spotlight. Never wavering from the Keynesian ideals of lower interest rates and increased government spending on infrastructure, Obama maintains that increased government spending will pull America out of recession, into recovery and prosperity. However, the rest of the world disagrees, leaving Obama alone at the G20 summit arguing for increased spending. With conflicting actions from world governments and an optimistic government contrasting a concerned public, there is little doubt that volatility will remain king on Wall Street and around world markets.

Will immigration reform provide the stability that Democrats need to win in the fall elections? With Republicans and Democrats in little agreement, and other issues on the public mind, probably not. Obama, along with the Democrats, has spread himself too thin over a variety of domestic and foreign policy issues, and the economy is bringing his popularity down.