What is the single most important factor in determining whether you should buy a particular stock? If you posed this question to a room full of investors you would get a myriad of different responses. The fundamentals. The technicals. The uniqueness of the product or service. Research and development. The management team and on and on. For me there is only one answer and it’s so simple I’m hesitant to state it. But here it is anyway: Are intitutional investors buying this stock? It is this group, not you and me, who move the price of an equity north. These are the mutual funds, hedge funds, and money managers of banks, insurance companies and pension funds.
So how do we find out what these “big boys” are up to? One way would be to surreptitiously sneak into their board room meetings and listen in. However, this approach is illegal and may require the use of Woody Allen eyeglasses with the furry eyebrows and big noses. Another method is to check out the price charts of that security, technical analysis. If we see an uptrending moving average with confirming technical indicators, we know that these players are taking positions in this stock and the momentum will be in our favor to join the party.
In order for us to feel confident in this approach, there needs to be transparency and accuracy in the prices and volumes reported. This is not an issue with the major exchanges but there is a hidden world of investing, called dark pools, that may be skewing the numbers and effecting our investment decisions.
What are dark pools? :
This is a slang term that references the trading volume created from institutional orders, which are unavailable to the public. The bulk of dark pool liquidity is represented by block trades (10,000 shares or more, not including penny stocks) facilitated away from the major exchanges. It gets its name because details of the trades are concealed from the public, clouding the transactions like murky water. In essence, they bring together buyers and sellers behind closed doors. These trades are considered legal and necessary for the health of the market but do bring up concerns for average Blue Collar Investors.
Why institutional investors prefer dark pools:
Huge trades can be made without institutional investors tipping their hands as to the their actions, which they say, can affect prices.
Who runs the dark pools?
They are run by brokerage firms such as Goldman Sachs and Fidelity Capital Markets, as well as brokers and other firms. There are currently over 40 dark pools. When the smoke clears, nearly 20% of Big Board stocks change hands in the dark! Because the NY Stock Exchange is losing market share to these dark pools, it is taking action. In a joint venture with BIDS Holdings, a dark pool owned by the major Wall Street firms, the NYSE is luring back these block trades-the large transactions this exchange once dominated- by allowing hidden prices.
Who is watching out for us ?
James Brigagliano, co-acting director of the SEC’s Division of Trading and Markets is watching our backs. In Traders Magazine on May 21st, 2009, he said that dark pools could impair price discovery by drawing valuable order flow away from public quoting markets…..” could adversely affect the execution quality of those market participants who display their orders in the public markets.” He stated that this could harm price discovery and worsen short-term volatility.
There is much the SEC does not know about the dark pool business. The regulatory agency has no numbers of its own on the size of the dark pools, relying instead on industry reports (uh oh!). The SEC does believe, however, that it has a right to such regulation.
Another concern of Brigagliano is the enhanced automation of market orders between dark pools which “could create the potential for significant private markets to develop that exclude public investors.”
What does this mean for us ?
In my view, there is currently nothing to worry about but the situation does bear monitoring. Garnering about 20% of the trading volume seems to serve a purpose for the institutional investors but not have a major impact on us. After the recent hits the SEC has taken (remember Bernie Madoff?), the agency is all over this issue. The SECs director of trading and markets, Erik Sirri, has said that if the volume flowing to dark pools were to become much larger ( over 30% of the total according to analysts), that would attract the attention of the regulators.
All we ask in this David and Goliath world of Blue Collar Investors trading alongside Wall Street Insiders is a fair chance, a level playing field. I believe that we currently do have that. Let’s keep an eye on those dark pools and ask that they not get greedy.
Top performing industries this past week:
Three of the industries that have been highlighted on this site for the past few months had a great week:
- Gold/Silver: + 11%
- Steel: + 9%
- Coal: + 7%
Here are the industry charts all with impressive uptrending patterns:
There were mixed signals from the Federal Reserve’s April meeting regarding the health of the economy. Stocks plummeted globally on the report that the Fed’s latest forecast for 2009 expects more contraction than the January forecast. On a positive note, the Fed has become more optimistic about the outlook for late 2009 and 2010. New residential construction declined 13% in April to a record low of 458,000 annualized units. Single family construction, however, was up 3% while multi-family units, especually condos were down more than 46% from March’s weak levels. This, in part, is due to builders’ restricted access to financing. The Conference Board’s Index of Leading Indicators increased 1% in April, the first monthly increase since June of 2008. For the week, The S&P 500 was up 0.5% for a year-to-date return of – 0.7%. Those of you trading or paper-trading covered calls, may be seeing the incredible power of this strategy when comparing your returns to that of the S&P 500.
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Wishing you and your families a happy and healthy holiday weekend,
Alan and Linda Ellman