There's much to mystify us today, from the basic meaning of life, to the "Peso Problem," to how anyone can conclude that more spending solves a spending problem (calls to mind the alcoholic who told his doctor, "I don't have a drinking problem. I have a stopping problem."). One thing that should, however, be no mystery to IROs and execs is what's behind price and volume.
Wait, now, it'll take learning new terms to rip the veil of obfuscation. New rules, new tools, we're fond of saying. For example, take the "Peso Problem" above. Writer Paul Krugman claims the term came from his MIT Econ classes. Economist Milton Friedman used it in the 1970s to explain differing returns from dollars and pesos. Back then, the exchange rate between dollars and pesos was fixed, yet interest rates were higher in Mexico than in the United States. The condition persisted, allowing speculators to profit by borrowing cheaply in the US, converting funds to pesos and investing in Mexico, then exchanging back at the locked rate and pocketing the interest gains. Friedman said the reason for an interest-rate gap where none should be was a belief that the peso could devalue. In 1976, when the fixed rate converted to a floating denominator, the peso plunged 46% in a single day. Ah, mystery solved.
We're not here to explicate the Peso Problem – though it explains frequent market anomalies ranging from oil prices to the gap between two peer-group stocks (we are fans of speculators, because they shine bright light into dark alleys) – but that new terms are needed for modern IR programs. Friedman (or Krugman, or MIT) gave us a new way to understand how markets priced risk. In the same way, IR folks need new terms to explain to management things that don't hew to old rules. Your value will surely increase at the management table if you can do more than shrug and go, "It was fast money."
This New Year's Resolution to increase your IR vocabulary and acumen does not require more skill or effort, either. In fact, we'd propose that it takes less – after all, I do it for a living, so what could be better proof that only minimal mental acuity is needed?
So, new terms. Let's take just one today: Rational Price. If you can learn how to identify the price at which human thought interdicts the machines, your Rational Price, you'll be more confident about telling management what your price will do. And what could be more helpful in establishing your value and overall coolness in the IR chair than that?
The simple beauty of modern markets is that they're highly mathematical. Rather than being a source of bitter-beer-faced befuddlement, the fact that math drives them means that differences and changes in the order flow and behavior are all the more apparent and predictable.
Rational Price is, very simply, the level at which human beings get impatient – through greed or fear – and try to get ahead of the machines. This invariably shows up in your volume. All you have to do is identify the entry points where it happens. And it will. Under Reg NMS, a remarkably small amount of volume out of kilter with best execution and the national best bid or offer will tip a rational hand. One more clue: look for big short-term changes, not for who're the biggest market makers.
Margaret E. Wyrwas - Knight Capital Group, Inc. (Nasdaq: NITE)
Senior Managing Director, Corporate Communications & Investor Relations
Equity Analysis™ subscriber since March 2007
"In global markets driven by automation, changing market structure regulation and dynamic investment objectives, today's investor relations professionals require new data points in order to remain relevant and add value in their company's quest to reduce its cost of capital."
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