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If your stock behaved schizophrenically on Thursday October 11th, you were not alone.
As a refresher, we categorize trading volume (the opposite of surveillance, which relies on settlement data) to sort of seismically graph the forces at work in equity trading. If the equity markets don't regain early October highs, we think the source of the rupture can be traced to trading on October 10th and 11th.
Rule of thumb, there are three major order flow currents behind your daily volume: a) electronic order-matching, b) program trading, and c) speculative arbitrage that occurs around these two other forces. It's typical for the three to drive 90% of volume. For equity markets to sustain efficiency and support both trading and investment, equilibrium among these forces is generally necessary.
Beginning October 8th, electronic systems began to separate from the pack and by the 10th represented 44% of total order flow, about 20% more than either programs or arbitragers. On Thursday, the big Prime brokers behind programs essentially said, "All right, everybody, out of the pool." Whether these actions were the result of the broker-dealers pressing the reset button themselves or responding at the behest of institutional clients is unclear. Whatever the case, the markets have not been the same since—and options expire this coming Friday right in the midst of third-quarter earnings reports.
So what happened and why should you care, IROs? We think big primes like UBS Securities are able to observe order-flow imbalances across multiple asset classes and perhaps even flex muscle for the sake of regaining institutional order flow. After all, if the buyside chooses to skip brokers and go straight to the markets through electronic systems, ultimately that translates to reduced revenues and earnings for broker-dealers. We also have a hunch that speculators in currencies ("forex") and commodities leveraging off equity platforms got ahead of their own models. Maybe this is why oil is trading at, um, schizophrenic prices.
Either way, these features affect the responses of institutions to fundamental business performance. If you don't understand their role in your equity market—call us redundant to the point of exasperation—you can waste precious IR time, money and effort working at results that can't be achieved.
And if you're blessed with great business catalysts…these market conditions are definitely your friend.
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