S&P 500 FUTURES: ALGOS GONE WILD

MrTopStep.com

For today: The million-dollar question: Is the S&P getting ready to break down? In normal times I would say yes, but ...

Yesterday the algorithms took over. Just look at your chart. In the first part of the day the ESM ran buy stops on the upside. Then it sold off and took out the sell stops. Over the first 5-1/2 hours the S&P futures acted like a bad game of electronic bumper pool.

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Algos3Jun2013

Yesterday we said several times that there was an upward bias. After the robots ran all the stops in both directions the true direction of the S&P was revealed. Late in the day but before the futures got to their end game, they had to inflict pain in both directions, up and down, before making their final decision...

Algos running amok

In all honesty I believe our desk has seen everything. Bond crashes, currency crashes, commodity crashes and stock market crashes and last but not least the flash crash. The floor operation had desks in almost every quadrant in the CME Group. We have traveled the world. We have had dinners with princes and lunches with sheikhs. We have seen the markets in good and bad times, 9-11 and both Gulf wars, up and down and all around, but we have never, and I mean never, seen the likes of what the S&P futures were doing yesterday. It was one of the heaviest mixes of index arbitrage and algorithmic trading I think I have ever seen on a non-event, non-crash day.


Distorted price action

One of the tools we use to follow the ES is the premium level between the S&P cash and the S&P futures. When the premiums expand we know the offers in the ES are for buy programs, and we know when the levels contract that the bids are for sell programs. In the wacky world of electronic trading the two generally work together. The algos chase the stops, and when the stops are elected an index arb buy or sell program is executed. That's how it's supposed to work, but yesterday the algorithmic trading constantly “shut down” the program arb. Even before the low of the day was established, the ESM was going bid for two or three handles, then getting hit by an algo searching for sell stops on the downside. After the algos ran the stops, the ESM would immediately run in the other direction.  


Worst 6 months for stocks

Most of us already know that the worst 6 months for stocks starts in May. While there seems like an exorbitant number of people willing to sell the S&P, the overall price action is still holding. In order to go down, the S&P will need to have more than just a one- or two-day decline. So far this year there have been no three-day selloffs, and until that starts to happen we just do not see the downside potential. Below is the MrTopStep year to date net change chart. While basic, it does show that the down days are increasing in size and frequency.

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YTD net changes 6-4

We have said many many times that we did not think there would be a “walk away in May,” but we still contend that there will be some type of selloff this summer. The way we see it is the Fed maketh go up and it will be the Fed that maketh the S&P go down ...


Our view: Asia closed mostly higher and Europe is inching up. After the big selloff late Friday the S&P came marching back up late in the day yesterday. The million-dollar question: Is the S&P getting ready to break down? In normal times I would say yes, but these are anything but normal times. This morning we have a few numbers and Fed speak to get past first. Our thought process is that yes, the S&P is seeing some downside rotations, i.e. cash selling. Is that going to be enough to overpower QE3? While there is a lot of talk about curtailing the program, there has been no time set for tapering or cutting it off yet. Until that decision is made we think we are in for more of the same, going up. Additionally, Tuesdays have been the best trading day of 2013, of the 21 this year 18 have closed up / 3 down, with an average gain of +9.3 handles and an average loss of -3.9 handles. Our view is to sell the early rally and buy weakness. As always, keep an eye on the 10-handle rule and PLEASE use stops when trading futures ...   

  •     It’s 8 a.m. and the ES is trading 1638, up 1.75 handles; crude is down 30 cents at 93.15; and the euro is up 23 pips at 1.3096.
  •     In Asia, 6 out of 11 markets closed higher (Shanghai Comp. -1.17%, Hang Seng +0.01%, Nikkei +2.05%).
  •     In Europe, 9 of 12 markets are trading higher (DAX +0.37%, FTSE +0.64%).
  •     Today’s headline: “Asia and Europe Rise; Fed’s Lockhart Backs Stimulus”
  •     Total volume: 2.51mil ESM and 10k SPM
  •     Economic calendar: International trade; Redbook; Sarah Bloom Raskin, Esther George and Richard Fisher speak
  •     Fair value: S&P -0.37, NASDAQ +1.21
  •     MrTopStep Closing Print Video: https://www.mr-topstep.com/index.php/multimedia/video/latest/mts-video-of-the-day-tim-haefke-6-3-13         

Danny Riley is a 34-year veteran of the trading floor. He has helped run one of the largest S&P desks on the floor of the CME Group since 1985.

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DISCLAIMER: The information and data in the above report were obtained from sources considered reliable. Opinions, market data, and recommendations are subject to change at any time. Their accuracy or completeness is not guaranteed and the giving of the same is not to be deemed as an offer or solicitation on our part with respect to the sale or purchase of any commodities or securities.

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