A large percentage of people are surprised to learn that the markets can be manipulated in the ways that we have described. Almost all traders are labouring under various misconceptions.
There are all sorts of professional interests in the world’s financial markets: brokers, dealers, banks, trading syndicates, market-makers, and traders with personal interests. Some traders have a strong capital base, some are trading on behalf of others as investment fund managers, pension fund managers, insurance companies and trade union funds, to name but a few.
As in all professions, these professionals operate with varying degrees of competence. We do not have to be concerned by all these activities, or what the news happens to be, because all the trading movements from around the world are funnelled down to a limited number of major players known as market-makers, pit traders or specialist (collectively know as the ‘smart money’ or ‘professional money’). These traders, by law, have to create a market. They are able to see all the sell orders as they arrive, and they can also see all the buy orders as they come in. They may also be filling large blocks of buy or sell orders (with special trading techniques to prevent putting the price up against themselves or their clients). These traders have the significant advantage of being able to see all the stop-loss orders on their screens. They are also aware of ‘inside information’, which they use to trade their own accounts! Despite ‘insider dealing’ being illegal, privileged information is used all the time in direct and indirect means to make huge sums of money.
To put it simply, a professional trader can see the balance of supply and demand far better than anyone else can. This information is dominating their trading activity. Their trading will then create an ongoing price auction.
Floor traders usually complain bitterly if they are asked to modernise, which usually means leaving the
floor to trade on computer screens. They will have lost the feel and help of the floor! “I am all in favour of progress, as long as I do not have to change the way I do things”, was a passing comment from one London floor trader as he was forced off the trading floor.
Professionals trade in many different ways, ranging from scalping (that is buying the bid and selling theoffer) to the long-term accumulation and distribution of stock. You need not be concerned too much with the activity of individuals, or groups of professional traders, because the result of all their trading is shown in the volume and the price spread. Firstly, the volume is telling you how much trading activity there has been. Secondly, the spread or price action is telling you the position the specialists are happy with on this activity (which is why the price spread is so important). All the buying and selling activity from around the world has been averaged down into a ‘view’ taken by the specialists or market-makers – a view from those traders who have to create a market, can see both sides of the order book, and who trade their own accounts.
However, you do need to recognise that professional traders can do a number of things to better their
trading positions: Gapping up or gapping down, shake-outs, testing, and up-thrusts are all moneymaking
manoeuvres helping the market-makers to trade successfully, at your expense – it matters not to them, as they do not even know you.
This brings us to the “smoke-filled room syndrome”. Some people may think that when we talk about a
moneymaking manoeuvre, some sort of cartel gathers in a smoke-filled room.
“OK chaps, we are going to have a test of supply today. Let’s drive the prices down on a few strategic
stocks and see if any bears come out of the closet”.
In practice, it does not usually work like that. This sort of thing was much more common many decades
ago, before the exchanges were built, and the volume of trading was such, that markets were much easier to manipulate. Now, no single trader, or group of traders, has sufficient financial power to control a market for any significant length of time. True, a large trader buying 200 contracts in a futures market would cause prices to rise for a short time, but unless other buyers joined in, creating a following, the move could not be sustained. If you are trading futures related to the stock market, any move has to have the backing of the underlying stocks; otherwise, your contracts are quickly arbitraged, bringing the price back in line with the cash market.
If we take the example of the ‘test of supply’, what actually happens is something like this:
Groups of syndicate dealers have been accumulating stock, anticipating higher prices in the future. They may have launched their accumulation campaigns independently. Other traders and specialists note the accumulation and also start buying. Before any substantial up-move can take place they have to be sure that the potential supply (resistance) is out of the market. To do this they can use the ‘test‘. Usually they need a window of opportunity in which to act. They do not collude in the test action directly; they simply have the same aims and objectives and are presented with the same opportunity at the same time.
Market-makers can see windows of opportunity better than most other traders. Good or bad news is an
opportunity, so is a lull in trading activity. Late in the trading day, just before a holiday, is often used and so on. As they take these opportunities, reduced effort is required to mark the prices down (this is now cost effective), the market automatically tells them a story. If most of the floating supply has been removed, then the volume will be low (little or no selling). If the floating supply has not been removed, then the volume will be high (somebody is trading actively on the mark-down which means supply is present). If most of the floating supply had been removed from the market, how can you have active trading or high volume? (This point refers specifically to cash markets).
Professional interests frequently band together. Lloyds of London, for example, have trading syndicates, or trading rings, to trade insurance contracts, making their group effort more powerful while spreading the risk. You accept this without question – you know about them because they are well known and have much publicity; you read about them, they are on television, they want the publicity and they want the business.
Similar things go on in the stock market. However, you hear little of these activities, because these traders shun publicity. The last thing they want is for you or anybody else to know that a stock is under accumulation or distribution. They have to keep their activities as secret as possible. They have been known to go to the extremes, producing false rumours (which is far more common than you would perhaps believe), as well as actively selling the stock in the open, but secretly buying it all back, and more, via other routes.
From a practical point of view, professional money consists of a mass of trades, which if large enough, will change the trend of the market. However, this takes time. Their lack of participation is always as
important as their active participation. When these traders are not interested in any up-move, you will see low volume, which is known as ‘no demand‘. This is a sure sign that the rally will not last long. It is the activity of the professional traders that causes noticeable changes in volume – not the trading activity of individuals such as you or me.
Top professional traders understand how to read the interrelationship between volume and price action.
They also understand human psychology. They know most traders are controlled in varying degrees by the
TWO FEARS: The fear of missing out and the fear of losses.
Frequently, they will use good or bad news to better their trading position and to capitalise on known
human weaknesses. If the news is bad and if, at that moment, it is to their advantage, the market can be
marked down rapidly by the specialist, or market-makers. Weak holders are liable to be shaken out at
lower prices (this is very effective if the news appears to be really bad). Stop-loss orders can be triggered, allowing stock to be bought at lower prices. Many traders, who short the market on the bad news, can be locked-in by a rapid recovery. They then have to cover their position, forcing them to buy, helping the professional money, which has been long all the time. In other words, many traders are liable to fall for ‘the sting’.
Market-makers in England are allowed to withhold information on large deals for ninety minutes. Even
this lengthy period is likely to be extended. Each stock has an average deal size traded and, on any deal, which is three times the average, they can withhold information for ninety minutes. If for example, trading in ICI, the average is 100,000 shares and 300,000 are traded, they can withhold this information for ninety minutes. Their popular explanation for this incredible advantage is that they have to have an edge over all other traders to make a profit large enough to warrant their huge exposure. As these late trades are reported, this not only corrupts the data on one bar, but two bars. To add insult to injury, you are expected to pay exchange fees for deliberate incorrect data. So professional traders can withhold the price at which they are trading at for ninety minutes or longer, if it suits them. However, the main thing they want to hide from you is not the price, but the VOLUME.
Seeing the price will give you either fear or hope, but knowing the volume will give you the facts. In
trading other markets around the world, you may not have the same rules, but if the volume is so important in London, it will be just as important in any other market. Markets may differ in some details but all free markets around the world work the same way.
As these market-makers trade their own accounts, what is stopping them trading the futures markets or
option markets just before they buy or sell huge blocks of stocks in the cash markets? Is this why the future
always appears to move first? Similar things happen in other markets – however, the more liquid or
heavily traded a market is, the more difficult it will be to manipulate.
You will frequently see market manipulation and you must expect it. Be on your guard looking for
manipulation and be ready to act. Analyzing volume will be an invaluable tool in helping you to
achieve this. Market-makers cannot just mark the price up or down at will, as this is only possible in a thinly traded market – most of the time, this will be too costly a manoeuvre. As we have already pointed out, windows of opportunity are needed; a temporary thinning out of trading orders on their books, or taking full advantage of news items (good or bad).
It is no coincidence that market probes are often seen early in the mornings or very late in the day’s trading.
There are fewer traders around at these times. Fund managers and traders working for large institutions
(we shall refer to these people as ‘non-professional’ to distinguish them from market-makers et al) like to work so called ‘normal hours’ – they like to settle down, have a cup of coffee, or hold meetings before concentrating on market action. Many traders who are trading other people’s money, or who are on salaries, do not have the dedication to be alert very early in the morning. Similarly, by late afternoon, many are tired of trading and want to get home to their families.
By Tom Williams