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The Case for Spitting into the Wind (At Least for Now)

You've heard the expression "You don't spit into the wind," haven't you?

Well, it's true when it comes to trading and investing, too. You keep the wind at your back, and you don't give up easy profits by bucking the trend.

That's all well and good, so long as the wind is coming from a discernible direction. I prefer a warm southwest breeze myself. That's why I live where I live (in Miami).

But we have no control over the many ill winds that blow over our investing horizons.

The best we can do is stay aware of subtle shifts in directional changes, and watch out they don't strengthen into hurricane-force monsters.

I've been cautiously (too cautious, I admit) bullish since October, and I remain optimistic that stocks have enough momentum to try and push through important psychological barriers – such as 13,000 on the Dow, 1,375 and 1,400 on the S&P 500, and 3,000 on Nasdaq.

That doesn't mean we won't see a correction first. Or that last Tuesday wasn't a tiny correction in and of itself.

But 30 years of hardcore trading, and catching every major move in that long time span (no, I hardly ever pick the exact top or bottom, but I have come close) has taught me to go with my gut, to know when I "blink" that it means something.

And lately, I'm starting to "blink" more and more…

I'm getting the feeling that something's wrong, and, somewhere, the eye of a terrible storm could be forming. There's nothing out there that I've read (and I read a lot), or heard, or come across in any research, either quantitative or fundamental, that articulates what this nagging feeling is that's hanging over markets.

So, it looks like I'll have to be the one to put it out there.

But first let me be clear. I'm not spitting into the wind here. I'm still going with the path of least resistance.

What I am doing is presenting the backdrop of what people have lost sight of as they look front and center on the investing stage.

Am I saying the eye of a hurricane is forming? No. I'm saying it already has formed.

I'm saying keep buying cautiously and keep raising your stops as markets go higher, if they do. I'm saying keep watching these developments with me.

Things change, and this brewing storm could dissipate, but it could also turn really ugly, really quickly.

If the storm strengthens, and that's my bet, have a fail-safe plan to get out of speculative long positions, a plan to selectively add to core positions on the way down, and a plan to put on short-side positions that will make you a ton of money if I'm right.

Okay, ready?

Here's where the winds have shifted…

Where the Winds Have Shifted

Structural changes in markets worldwide have occurred. Electronic trading has changed everything.

In the old days, there used to be market-makers. (I was a market-maker on the floor of the CBOE and an over-the-counter "OTC" market-maker.) The job of market-makers is to make a two-sided market in a stock or other instrument. In other words, you have to be willing to buy at a posted price and sell at a posted price, your posted price.

Specialists on the New York Stock Exchange are the best examples of market-makers. Back in the day, when all orders for a stock that was only traded on the NYSE came down to the floor, the specialist in that stock kept a "book" (it used to be an actual leather book) on that stock. In it were all the buy and sell orders from all over the world. In addition to keeping the book, the specialist also made a market, meaning he or she could set their own price inside the public's quoted bids and offers to narrow spreads and transact for their own accounts. As they traded the stock they were specialists in for themselves – they still are.

Then electronic trading took hold.

Instead of just one place where one stock was traded, there are now many different exchanges or electronic platforms where stocks are traded.

The need for market-makers has disappeared as individual traders put their own buy or sell orders down wherever they want, or where their trading platforms direct them (in most cases).

In other words, there are no market-makers keeping fair and orderly markets. Bids and offers coming into electronic venues from across the globe constitute what the market is (the bids and offers) for any instrument.

At the same time that electronic trading was growing, decimalization replaced the system of trading stocks in sixteenths and eighths of a dollar. Now everything trades in one-penny increments.

The combination of electronic trading and decimalization decentralized trading and made it much more volatile.

Essentially, the unintended consequence of changing basic market structures scared off long-term investors looking for stability… and replaced them with a frenetic trading crowd that now includes non-professional (though they think they are) day-traders and non-professional speculators who tend to jump onto trends (usually as they are peaking) once they are the hot new game in town.

Of course, these non-professionals are a drop in the bucket compared to the "professional" crowd that has exploded to get into the very lucrative game of trading volatility.

Keep in mind: Volatility is anathema to investors, but manna from heaven to traders.

Into this mix of structural changes, we have to add the hugely popular and massively traded derivatives universe. Most individual investors will never touch these instruments directly, but they are constantly affected by them, one way or another.

So we have a market that moves on thin volume, because investors are more inclined to be traders, ourselves included.

Skeleton Market Tends to Get Crushed

As spreads have narrowed because of decimalization and electronic trading, so have time horizons for holding stocks and reasons to hold them.

What we have are rising markets based on short-term assumptions that are not underpinned by long-term investors willing to add to core positions if markets correct.

Because the market structure now resembles a skeleton, as opposed to a fully complemented living organism, overhead weight or sideways winds can crush it or blow it apart.

Innumerable research reports and white papers (they will make you blue in the face if you read them all) support exactly what I'm saying — that markets are a shell game these days.

Here's the latest support for what I'm telling you.

How is it possible that less than $1 billion flowed into domestic-stock mutual funds since the beginning of 2012, but the value of Wilshire 5000 index (an index as broad as they come) rose by $1.5 trillion?

Where is the increase in value (share prices) coming from if there is no meaningful capital flow into stocks?

Starting to get my fear?

As speculators go after stocks, they take smaller and smaller bites of what's being offered for sale. That's because there are not a lot of sellers. There aren't a lot of sellers, because there aren't a lot of long-term holders in the first place.

The sellers that present themselves (especially short-sellers) aren't offering a lot of stock. So, if you want to buy, you take what's offered, and step up and take the next higher price, and so on, and so on. You might end up buying not a lot of stock, but you might have moved the price up a good bit. Everyone sees that, and thinks, great, stocks are rising.

But, where's the beef?

ETFs have added to the speculative fever. But, again, what are ETFs other than mutual funds that trade like stocks? And where has the $16.4 billion that's gone into ETFs since December gone? Mostly into bond funds, believe it or not.

What I'm worried about is that this shell game faces a headwind that shatters the illusion of huge numbers of investors holding onto core positions. They aren't.

When a macro event happens — and one will — will speculators, hedge funds, and high-frequency traders step in at lower levels perceiving value? Will investors come off the sidelines and finally get involved? Or will they climb on board this rising shell game, only to get spit out when the day of reckoning comes?

Massive liquidity has floated speculation for the past three years. We'll see what happens next.

As far as Greece goes, PLEASE, don't be fooled.

Tuesday's sell-off was about Greece not getting its bond swap. It got it. Now, good luck with that… On Thursday, I'll tell you the truth about what really happened and what's going to happen next over there. It ain't pretty.

So, for those of you looking to jump onto Europe's gleaming prospects now that the Greek debt crisis is resolved, go ahead. Just don't spit into the wind when it comes.

And the wind is stirring.

[Editor's Note: If you're looking for some sound advice on the direction of the markets then you need to read Shah Gilani's Wall Street Insights & Indictments newsletter.

As a retired hedge-fund manager, Gilani opens the doors on Wall Street's private money club — where his experience and knowledge uniquely qualify him as an expert on the markets.

Bull market or bear, Shah knows how make money in any market.

Please click here to find out more about Shah's free newsletter.]

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. maikel romeo | March 13, 2012

    solf it for me then.

  2. Mark Koss | March 13, 2012


    Thank you for pointing out what I have been saying for years. Your analysis and conclusion with respect to the change in the way stocks are traded is spot on. Having been a market maker myself on the CBOE from 1979 to the end of 1994. You have explained the change in hwo the markets work well. I believe that you did not explain one very important point very well. Let me try. Back when we were market makers we had an OBLIGATION to make a two sided market that had at least a specified minimum number of contracts available at the quoted price. Our job was to make a FAIR and ORDERLY market. We were fined or suspended when we did not perform as required. In todays electronic marketplace where certain participants are actually allowed to pay a premium so that they get priority on each and every order has no such requirement to make a two sided market and to maintain a fair and orderly market. Basicly these HFT's get the perks without the responsibility that goes with being a market maker. I believe this piece is the most crucial part to the scepticism the investing public now has. There is no honor. Back when we were maket makers we knew that the public customer was our life blood to making a living.

  3. Ernie Bullock | March 13, 2012

    Take a look at a recent chart of the US stock market indexes.
    The first thing I notice is volume has been drifting down on the charts since September 2011 (earliest date shown). Actually volume has generally been going down since at least May 2010. Steady declining volume is not the signature of a new bull market. The second thing I notice is that prices were much more volatile before the last week of December. But since December, the up-and-down motion has been much more subdued, and the corrections have been very shallow(abnormally so). The third thing I notice is that the NYSE short-ratio is 16% — which I know to be
    historically ‘very high’. I also notice: as the market continues to rise most of the shorts aren’t ‘giving up’. I would expect them to give up more easily if this was a new bull market.

    To me, this is a market which looks like it is being manipulated by ‘big money’. They are deliberately supporting the market, and spurring it upwards via their small buys (usually short covered). Remember that a stock’s price is determined by the 0.0001% while the majority sit idly by. The lack of volume tells me big buyers aren’t committed to this rally. That fact — when combined with the high short ratio — tells me in fact exactly the opposite. The biggest fish (sharks really) are actually laying a trap for the small or dumb investors.

    So why would the ‘big money’ do this manipulation? And why now? Let me lay out the picture:
    First off, the beginning of each year presents a unique opportunity. Since Investors Business Daily (and many other) financial rags restart their YTD calculations in January, large financial houses can easily engineer a convincing rally … while still using only small amounts of capital. With no leading YTD data to drag-down (or buffer) new results, and now with an abnormally low market participation rate, today is the time to push markets up by using small and carefully timed buys.
    Second, since 2007 large investment firms, insurance companies, pension funds, and the like have all been attempting to rebalance their portfolios towards ‘more bonds, less stock’. As an example, The Sacramento Bee reported CalPERS’s portfolio was about 66% stock in August 2011, down from 70% reported in 2007. CalPERS goal, as I remember, is to reduce their portfolio to 50% stock. Meanwhile — even as the existing money is lining up at the doorways to leave – ‘new money’ is going down too. As example, Investment Company Institute surveys repeatedly show ‘net new money’ has been leaving stock funds pretty much continuously since the Financial Crash of 2008.
    Third, despite the media’s valiant attempts to ignore it, recession shadows the world. Recent The Economist issues state recession is now occurring in many European countries. And recession has been predicted as a ‘certainty’ for the U.S. by the Economic Cycle Research Institute sometime mid- 2012. In the past ECRI’s predictions have been very accurate.

    So we have [1] the opportunity to manipulate the markets cheaply, [2] a desire to sell lots more stock without crashing the price, and [3] signs of more financial crisis ahead.

    So how does one sell large blocks of stock into a weak market? A popular investment book, Reminiscences of a Stock Operator explains:

    It is a cardinal principle of stock manipulation to put up [raise the price of] a stock in order to sell it. But you don’t sell in bulk on the advance. You can’t. The big selling is done on the way down from the top. [page 260]
    Usually the object of manipulation is to develop marketability – that is, the ability to dispose of fair-sized blocks at some price at any time. … In the majority of cases the object of manipulation is, as I said, to sell stock to the public at the best possible price. It is not alone a question of selling but of distributing. It is obviously better in every way for a stock to be held by a thousand people than by one man – better for the market in it. So it is not alone the sale at a good price but the character of the distribution that a manipulator must consider. … Stocks are manipulated to
    the highest point possible and then sold to the public on the way down. [page 245-6]
    … As the market broadens I of course sell stock on the way up, but never enough to check the rise. … By being short I always am in a position to support the stock without danger to myself. … Sometimes a stock gets waterlogged, as it were; it doesn’t go up. That is the time to sell. The price naturally will go down on your selling rather further than you wish, but you can generally nurse it back. … When my buying does not put the stock up I stop buying and then proceed to sell it down. … The principal marketing of the stock, as you know, is done on the way down. It is
    perfectly astonishing how much stock a man can get rid of on a decline. [page 249-250]
    … on the way down I could reach those buyers who always argue that a stock is cheap when it sells fifteen or twenty points below the top of the movement, particularly when that top is a matter of recent history. [page 283]

    And that’s what I see the ‘big money’ is doing now: setting us all up to ‘buy the dips’. Naturally, starting at the highest price possible. So smart small investors, in my humble opinion, should sell their longs before the rush down, and consider when to going short.

  4. Laurie | March 14, 2012

    Hi Shah,

    A couple of years ago the NYT Market page started to show yesterdays close price on their 5 day S&P DOW NAZDAC chart. When you see the 4:00pm close price from the previous day you notice that the only time there is no market volatility is when the lines start point (after queue'd & overnight trades are cleared sequential electronically) is the same as at 4:00pm the previous close i.e. there were no other queue'd trades cleared.

    I don't suppose anybody would bother to play the real market when you could just stack your up/down trades in the last 30 seconds because you knew how long it was before the market closed and how many other trades are to be processed before yours and the close and you could tier your trades so as to ramp up/down the price until you struck the rise/fall limit set for that particular trade in the electronic clearing program after the market closed. As long as the difference between your trades is within the range specified in the trading program you can guarantee that your sequential series of trades will ramp up/down to their programmed limits.

    Considering that the free market is a parallel system when open and a serial system when closed/opening why would you bother operating on the transparent/parallel side, especially if you could even do it to yourself when the lights were out and nobody would know (that you had an incredibly tiny penis).

    And the best thing is that after you artificially inflate/deflate the market at whim, with the help of your old mates of course, you can then sell/buy when the profit suits you and start rolling in the free moolah by lunchtime. If you doubt me calculate the average ratio between the rise/fall of the DOW before when the market closes and open trading resumes and the rise and fall between the markets 4:pm close and the next/previous days 4:pm close. When the dark side of the market accounts for between 50% to 200% of the next/previous open markets rise or fall you would have to be a fool to play on the side that the regulators look at.

    I equate this to it being much easier to suck the grease out of the bearings of a very great machine because its so much easier to do than actually using the machine for its intended purpose. Pity about what happens to the great machine when the greece runs out.

    The only time these serial scammers lose is when the market actually continues going up/down and does not correct the artificial manipulation and present the expected profit (20%, 1 out of 5 days). Unfortunately these times, when something else apart from serial manipulation drives the market, are few and far between.

    I don't think anyone has seriously started looking into who is involved in this rediscovered philosophers stone but I think the exec who resigned from GS today nailed it pretty good.

  5. FRED HORTON | March 17, 2012

    I have bought silver pre-65 coins, silver rounds, Silver Eagles and 100 oz bars for investment and emergency purposes.

    Which is the best for investment purposes.

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