Thursday, October 12, 2006

The TIKI room

Guambat's favourite Disney attraction was the Tiki Room. Lame, I know, but so it goes.

The following article discusses the TIKI measure as a stock trading tool, and lends support to the rant Guambat has had about the distinct change of character in the equity markets over the last decade.

Half of what you see on the screen isn't real
Suppose you see the S&P 500 Index (ES) futures rise a full point in a short period of time on solid volume. Seeing the market rally, you jump aboard, only to have the entire move retrace.

What happened?

In a nutshell, that move you saw on the screen wasn't real.

Yes, the index rose on buying, but what you didn't see on the screen was that the very same buyers of the index were selling the S&P 500 Index ETF (SPY). Once the futures moved a full point higher, exceeding fair value, they then sold the futures against a basket of stocks in the index to bring the futures and cash back into line. The moves were real, in the sense that they genuinely cost traders money. They're not real, in the sense that buying or selling did not reveal bullish or bearish tendencies on the parts of large market participants.

According to H. L. Camp, about 45% of all NYSE volume is now attributable to program trading. What that means is that the buying or selling you see on the screen may or may not reflect genuine demand or supply in the marketplace.

Most readers are familiar with the NYSE TICK, a measure of how many New York stocks are trading on upticks (at their offer price) vs. downticks (at their bid price). Let's say that, instead of measuring the number of NYSE stocks trading at their offer prices vs. those trading at their bids, we simply focus on the Dow 30 Industrial stocks and investigate how many of them are trading bid vs. offer. The resulting statistic is called TIKI and, it too, can be viewed as a sentiment measure. When Dow buyers are aggressive, they will be willing to transact at the stocks' offer prices, and you'll see TIKI values skyrocket above +20. When Dow sellers are aggressive, they're willing to bail out at the stocks' bid prices and TIKI will plunge below -20.

Because the Dow stocks are quite liquid and trade frequently, the TIKI moves much faster than the NYSE TICK. Its values are also distributed very differently from the TICK; TICK and TIKI correlate significantly (around .60), but hardly perfectly. The majority of variance in TIKI cannot be explained by the general buy/sell sentiment captured by TICK. Something else, apart from general market buying or selling impacts TIKI values.

The reason for this is that TIKI is highly sensitive to program trading. Whenever a program is executed that calls for the simultaneous buying or selling of a basket of stocks (arbing stocks against index futures would be a common example), TIKI values will shoot very high or very low. The Dow stocks, being liquid, are frequent components of such stock baskets. When the Dow stocks move in unison, it is often because programs are being set off.

The moral of the story is that markets today are different than they were a decade or two ago. You can't necessarily trust what is on your screen or what your price-based indicators are telling you. Who is in the markets ultimately impacts what markets do.

There's more of this at the link, and worth the read.


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