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Get Four
|  | AUGUST 6, 2004
By Amey Stone On the Street, the Tough Crowd Rules Ruthlessness and randomness prevail thanks to hedge funds, leverage, and program trading. What's a small investor to do? Imagine the prototypical professional investor. If you picture someone sitting behind a desk, reading annual reports and pondering the valuations of companies like Coca-Cola (KO ) and General Electric (GE ), you'd better think again. The big players in today's market are a different kind of crowd: brainiac hedge-fund managers using complex algorithms to identify obscure arbitrage opportunities, multibillion-dollar mutual funds buying the entire S&P 500 through program trades, and frenetic in-house traders at giant brokerage firms making snap decisions on the direction of emerging-market debt securities (see BW Online. 8/6/04, "Hedge Funds Are Everyone's Problem"). QUICK ON THE DRAW. Trading done by this crew is fast, short-term, and often highly leveraged. It is as likely to be driven by cues from a computer or technical chart as it is by any traditional stock analysis. Increasingly, the goal is not just to trade off news, but to trade ahead of the news -- to anticipate it. "The rule used to be, wait until you see the whites of their eyes," says Michael Panzner, a trader at Rabo Securities and author of The New Laws of the Stock Market Jungle, which details changes in the investment environment. "Now people aren't waiting until they see anything. They are shooting at the air, hoping the bullet hits." For individual investors, the effect of all this is to make the markets more unpredictable than ever. Wondering why a stock went up? It may have nothing to do with what's going on at the company (See BW Online, 8/6/04, "The New Rules of Investing"). Longer-term investors should do their best to ignore all the noise. But if your strategy relies on short-term indicators, "Don't kid yourself," says Greg Forsythe, who directs Schwab's equity ratings group, "there is a lot of competition out there. You are swimming with the sharks." HIGH-TECH SWINGS. This shift in speed and predictability of stock investing has taken place gradually over the past decade, and is likely to continue as markets become ever more high-tech. On Aug. 2, New York Stock Exchange chief executive John Thain announced his proposal for a hybrid market that would ramp up use of the exchange's electronic trading platform at the expense of its traditional system where real people, known as specialists, called the shots from the floor of the exchange. Program trading (baskets of more than 15 stocks worth more than $1 million and trading all at once, as the exchange defines it), now makes up more than 50% of trading on the NYSE (up from less than 20% in 1998). But market strategists estimate that about 75% of all trading done today is computer-driven. Program trading first made its appearance in financial headlines because it was believed to have contributed to 1987's stock market crash. Since then, exchanges have instituted limits on such activity that kick in during big market swings. Nonetheless, sudden, sharp intraday spikes or sell-offs in the markets are routinely (and inexplicably) triggered by program trades, strategists say. Asset flows into hedge funds -- those high-voltage, loosely regulated, opportunity-seeking funds crafted for high-net-worth investors -- continues to surge. Hedge-fund assets have grown from about $50 billion in 1990 to more than $850 billion in 2003 and are expected to soon reach $1 trillion. Hedge funds often use strategies involving derivatives, short-selling, and futures and options. One sign of their impact: The Options Industry Council reported July 7 that the month's equity option volume was running 42% higher than last year.
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