We saw a pattern today that has been repeated several times in the last few weeks: the markets trade up for most of the day, then suddenly crash just before the close. The down lost a couple hundred points in a matter of minutes; the NASDAQ and the S&P 500 saw like losses.
How to explain this behavior? Do investors just get sad at night? Not exactly. It seems like people's risk horizons have shortened to nearly nothing. People don't want to hold things overnight, so they dump them near market close. In the credit markets, we've seen a similar shift towards shorter and shorter credit terms.
Or perhaps there's another explanation I haven't thought of--readers invited to offer alternatives in the comments.
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I'm guessing that day trading is up, it being a good time to buy in big quantities and dump asap.
Anyone want to take bets on when it hits 8000?
I don't know what's behind it, but it's pissing me off. I suspect there's a lot of large investor (pension funds, hedge funds, etc.) unwinding going on, i.e., wait until the market bumps up a little, then dump the holdings. There are some good deals right now, and I have to think we're closer to the bottom than not, but enough already!
When are hedge funds most likely to sell stocks? The fund managers that I've talked to think that the reason that stocks have done so badly recently is that hedge funds have had massive withdrawals and keep having to sell because of redemptions. If they have to get funds out by the end of the day but are judged by how they do relative to the closing price of the day, or if they just think it's good to wait when prices are rising but then are forced to execute by the end of the day, that could explain this pattern.
Just a suggestion: I believe that mutual funds are facing waves of redemption orders every day, which must be cashed out at market closing prices, so they have an incentive to sell near the end of the day to ensure that they receive enough proceeds to honor the redemption order at the required price.
Note that most mutual fund investors, like me, are the opposite of Ms. McArdle: we have altered our investment strategies, forsaking the buy and hold strategy so beloved of Prof. Siegel, but have not altered our political affiliations.
I wouldn't worry about this too much. The stock market is always more volatile near the open or close and in a VIX-80 environment, you'll see this.
What worries me more is politicians who try to govern to the market and who worry about 401k values...
I suspect someone is answering this while I'm typing, but I suspect the problem is that all the net mutual fund redemptions that occur during the day have to be met at the end of the day by sales [or less commonly, purchases].
-dk
It sounds like y81 knows more than me about how hedge funds settle redemptions. If they're expected to pay based on the closing price, then they have an incentive to keep up this pattern, since selling at the close lowers the fund's risk even if it also gives the investors a lower expected return.
Bergamot,
Judging by the last few days, it'll dip below 8,000 tomorrow. It's sitting at 8,175 at the end of the day today. A drop of 175 points doesn't seem to be out of the question.
You have a limit order on DIA or something?
I gotta agree with y81. Funds are probably cashing out at the end of the day.
If funds like to cash-out at the end of the day, this provides an obvious way to make money: Buy up stocks at the end of the day, hold overnight and then sell them in the rising market the next day. It could be called "Night Trading".
[paranoia]
Since no one else is saying it, I will. it's because the evil George Soros and Warren Buffet are crashing the market at the end in order to depress people and get them to vote for Obama.
/paranoia
:-)
Ann, I am talking about mutual funds, not hedge funds. Most hedge funds, to my understanding, allow redemptions only on a quarterly basis and don't guaranty to cash you out at precisely their net asset value on a particular day. It is understood that hedge funds frequently hold large, illiquid positions so it would be difficult for them to guaranty an exact dollar price upon redemption.
I think your guess is right. The more volatile the market is, the more dangerous it is to hold overnight. If news comes out outside of trading hours, you can be ruined without a chance to respond.
This is standard / common behavior when trading in a range near the bottom. The pattern is one that also usually means the following day will open lower because the number of buyers have been exhausted at the end of the day leaving few buyers and more sellers. It is simple supply and demand and as long as things stay the same (ie polls showing Obama poised to win presidency) there is no incentive for investors to get in. Thus when things get near the bottom of the trading range short sellers will cover and a few bottom feeders will grab a few bargains. But that doesn't last for long and by the end of the day the momentum is exhausted.
btw - don't forget a lot of this behavior is driven by program trading.
Today was an extreme example, selling off 200 points in the last ten minutes. However the typical pattern of rallying during the day and fading at the close is very typical bear market behavior. The opposite is true in bull markets.
Just a guess but I expect in a few days we might read a story about a particular liquidation that hit the S&P floor and overwhelmed the traders and we took a dive that was only saved by the bell.
We're still in earnings season. A bad report, pretty much always released when the market isn't open to avoid a trading suspension, takes effect over night and the underlying issue gaps down. Thus in this environment, stop-loss orders don't work. Last night, Asia sold off about six percent, roughly the same thing it did Friday. The selloff in the Nikkei, Shanghai, and Hong Kong exchanges projects a deep US recession, since we're their customers. That means extended crummy earnings reports here and downgrades by the analysts. So people decide to sell, and try to wait for a rip to sell into. Today, they got a hundred points of bounce and didn't want to face the possible overnight gaps.
Another problem is the Credit Default Swap commitment overhanging the market. A lot of this stuff still needs to be unwound. It is estimated at 63T (yes, that's trillion) dollars. For purposes of comparison, the world GDP is 54T. The market is unlikely to stabilize with an overhang of that size. Does that help?
I was going to say what y81 said--mutual fund redemptions. When you call your mutual fund to redeem shares, they say that they will give you the closing price. So I assume they try to execute a sale at the day's closing price. If they sold in the middle of the day at $10, and the price went up at the close to $11, they would lose and you would win. It's true that the close could be $9 and they would win, but that's not a risk they're in the business to be taking.
It's called "selling into strength". Smart investor cash out when the market rallies.
The conventional wisdom seems to be that it's mutual funds selling for the reasons mentioned by others above and hedge funds as well, even though the hedge funds don't face daily redemptions. There's plenty of evidence that mutual fund redemptions have, in fact, been enormous lately, just as one would suspect.
A lot of it has to do with the mechanics of the closing auction (at least on the NYSE). A rather large volume of trades happen at the closing price. To determine the closing price, the specialist takes market-on-close and limit-on-close orders until 3:40pm. In order to match those orders, starting at 3:40pm the specialist publishes any buy- or sell-imbalance in an attempt to attract additional offsetting orders (this is, btw, why volatility spikes only after 3:40pm). If there are insufficient liquidity providers (e.g. hedge funds) willing to submit additional limit-on-close orders, you end up getting very large price moves in order to clear the closing auction.
There may be a lot of truth to the mutual fund theory, although those generally post as the last trade of the day and wouldn't show up at all until the following morning (or perhaps an extended trading session.
I will offer margin calls as a possible answer. When you purchase stocks on margin, you are only allowed to get so far upside down before the brokerage starts liquidating your position. Depending on what you're holding and how much of it was purchased with their money, the final margin call sale won't actually be determined until near the end of the trading day. They're always market orders and there can be something of a race to close a particular position before another brokerage can swamp the market maker.
It's always worth remembering that there's no such thing as "the" market, that does what "it" thinks. There are a whole bunch of individuals making individual decisions. Thus, many of these explanations are likely correct in part. That said, the market has, as you note, been tending to open low, move up, and come back down to near the open. Given that, anyone who is trading and who stays long at the close will lose money as long as it continues. Anyone who starts with cash, buys at the open, sells out early in the afternoon, and is 100 percent in cash at the end of the day, is going to sleep well that night.
It's because of the disaster that is striking overseas markets right now. The first 5 minutes of trading represent the reaction to whatever happened overseas overnight, and the last 5 minutes of trading represent anticipation of what will happen overseas the next night. If you want to know how the US markets by themselves are doing, you have to focus on everything in between.
Interesting. So maybe instead of closing the markets, we should force them to stay open 24 hrs a day?
Take that word investors out of your vocabulary. It's a silly word that's an impediment to understanding.
Liquidation. Hedge funds are being forced to liquidate. Now CaLPERS is actually selling. A lot of institutions are being forced to liquidate from the leveraged positions.
It's a bear market. Bear markets operate differently than bull markets. Smart speculators sell into strength in bear markets. This is a primary bear market with an extremely strong trend. Bear markets relentlessly bleed bulls and longs. That's just the way it is.
The most vicious rallies are bear market rallies. From the low on Fri 10/10 to the top Tue. 10/14 was nearly 2000 Dow points. A prototypical short covering rally. After that shorts got shy. One can guess that speculative short positions might not be very plentiful.
Markets are not rational. They move on three things
1 greed
2 fear
3 liquidity. (this is the biggest shrinkage of systematic liquidity in world history. Because we just had the biggest expansion of liquidity in history)
Late day margin calls
Who is gonna carry a position overnight in these markets? Not to mention all the wounded pools of money out there and the necessary liquidations, and the continued bad news.
We will probably see Dow blow right through 8000 before week is out.
But at least we know, per Megan, that the markets are rational.
My bad. I haven't been getting enough sleep lately. I dozed-off and went face first into the keyboard. At least I don't work at the nuclear plant anymore.
There's a bigger question.
If a repeatable pattern can be discerned in the market, then someone ought to be able to capitalize on this pattern (in this case, buy at 4pm, sell at 2pm the next day). More specifically, any repeatable pattern, once recognized, ought to be traded into oblivion.
In this specific case, there ought to be enough counter-market traders buying at 4pm, selling at 2pm, and rubbing themselves in money that it smoothes this curve out.
The fact that they can't/haven't means that they can't get enough leverage to do so and that other entities are contractually forced into end-of-day selling.
What is occurring is market makers are taking in stock during the day. They then offer it at higher prices. If there are no takers, they hit the bid in the last hour to get out of the position.
This has been going on since the days of the buttonwood tree. There is more downward pressure now because there are no takers on the upside during the day.
Meagan you ought to date a trader for a date or two and he will explain all this to you.
Market makers at the NYSE, the only place that has them, are more and more irrelevant. From 60% to 90% of volume is now basket trades done outside the specialist system.
Investors from other time zones chiming in?
R Wenzels dating idea has merit. I've learned lots from girlfriends who worked in finance and personnel.
It's a normal bear market behaving like itself. There was a little piece in the latest economist mag on this. Very straightforward.
"Okay, pork belly prices have been dropping all morning, which means that everybody is waiting for it to hit rock bottom, so they can buy low. Which means that the people who own the pork belly contracts are saying, "Hey, we're losing all our d* money, and Christmas is around the corner, and I ain't gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain't gonna f... my wife ain't gonna make love to me if I got no money!" So they're panicking right now, they're screaming "SELL! SELL!" to get out before the price keeps dropping. They're panicking out there right now, I can feel it." - Eddie Murphy, Trading Places.
Substitute "month" for "morning," and that's my theory.
We are currently forming the head of a head-and-shoulders. Of course, if things go badly the market may lose its head. So, keep your head.
short-selling? what about short-buying? what goes down... must... have gone up before? how does one keep a bubble from bursting?
Wow, Megan, you sure get results! You point up the pattern, and, like secret asian man suggested, people jump all over it and send things the other way!
:-)
Not mutual funds, at least for some of the reasons given. Mutual funds price at the end of the day, but make trades during the day on the fund's behalf. If ABC fund sells 1000 shares of DEF stock at noon for $10, then $10,000 is the amount of assets from the position that go into determining price at the end of the day - whether DEF closes at $1 or $20.
The fund is totaled up once daily for pricing, but the trades the fund makes happen in real time.
Though it's possible that funds are selling positions to get the liquidity needed to meet redemptions, the funds don't have to wait until the end of the day to reduce their exposure to market fluctuation after they've sold, they just have a much better idea of what their liquidity needs are then.