The Changed Nature of the Market & Price Manipulation on the ASX.

posted on February 9th, 2011 by Bellmont Research Team

Traditional forms of technical analysis have been practiced for decades with limited success. Most of the technical analysis methods taught to the public currently have not changed much for many years.

The entry points on patterns and trendline breaks are fairly easy to predict and the stop loss calculations most traders use are limited to a few methods.

However, the nature of the market has changed and the speed with which price moves has made the implementation of a conventional trading strategy much more problematic than it used to be.

Algorithmic trading has delivered an eightfold increase in the number of share transactions on the Australian stock exchange in just five years – but sharply reduced the size of each deal as disclosed recently by the ASX.

Trading statistics published by the ASX show that close to 1500 transactions a minute are being processed, compared with barely 200 in 2005. The weekly range of motion or average true range of a stock like Rio Tinto has increased on average 4-5 times compared with its ATR in 2005.

However those averages disguise peaks of activity, most often observed at market openings and closes. In 2006, the number of changes in the order books (buy and sell orders) peaked at about 2000 per second, while in the last year they hit 12,000 per second. For comparison, the current system has the capacity to handle up to 20,000 orders per second. If it continues to increase at the current rate, it will reach capacity by the end of this year unless computing power increases at a greater rate and the ASX stays ahead of the game.

The ASX would like the trading market to believe that the steep climb in the number of transactions reflects algorithmic traders breaking up a buy or sell order into hundreds of smaller deals that can be executed simultaneously, so that the market price is not changed significantly by their activity.

However, as this article will show, the other use of algorithmic trading programs is to create rapid movement of price to ensure that traders using traditional (known) trading methods are either trapped into bad trades or have their stops hit before the price rises.

In short, algorithmic traders manipulate the price in order to disadvantage traders who are unaware of the danger to their trading balance.

In conventional trading methodology, traders are taught to enter and exit a trade in a finite number of ways. Trading methodologies are widely taught and freely available in print and from trading educators. Entry criteria normally include breakouts from flags, pennants and triangles, falling resistance line breaks and rising support breaks.

Exit criteria, including placement of stop points are also widely known. These include but are not limited to penetration of a rising support line or falling resistance line, the first major low preceding the entry point, and an average true range trailing stop. It is also widely known that most traders trade emotionally. After a trade has run past their entry level, many traders will put their stops at the entry levels to make the trade become “risk free”.

Given the limited number of trading methodologies that are commonly used, if you were in the position of a competitive algorithmic trader and you had the ability and capacity to move price on an instrument, you would move it to counter the commonly used methods, too.

If you were a football coach and you had the opposition’s playbook, you’d use it, wouldn’t you?

In today’s high frequency marketplace price can move very rapidly. This is often done to the detriment of traders using traditional methods as the following charts show:

Chart1

Above is the chart of Watpac (WTP.ASX). I would like to draw your attention to the price action on the 17th and 18th of January. In two days, the price moved from $1.90 to $1.95 down to a bottom price of $151.5. That is a 28.7% movement in the price of a top 300 company.


Did the fundamentals of the business change 28.7% in 2 days? Did the market segment interested in Watpac jump schizophrenically from euphoria to despair about its future value in 2 days? How would the valuers who determine the price to earnings ratio explain this? What possible explanation could there be for the rapid upward movement and rapid downward movement followed by settling at long term average, other than price manipulation?

The price action on the 17th was designed to trap traders into poor long positions. The price action on the 18th was designed to trigger any stops long traders may have had. This price movement on the 18th was designed to take out all stops set below the long term trend line, any of the previous three major lows and any traders who had entered in the previous several months who panicked about being down by 20%.

And it worked as shown by the volume traded on the 18th.

Chart2

Another common pattern of price action that indicates that high frequency traders are manipulating price is the rapid price movement of an instrument prior to an upwards run. Find above a chart of STW Communications Group (SGN.ASX). I would like to draw your attention to the price action on 7 May in the centre of the chart. This price opened at 84 cents and plunged rapidly down to 76 cents before closing at 88 cents. The range of motion doubled the daily average true range.
Since many traders set their stops at major lows, the major lows on the 22nd of April, 24th of March, and 19th of March would all have been triggered by this rapid price movement. Often these rapid price movements occur at lunch time when traders are away from their desks and are unable to prevent their stops from being triggered.

This type of price action is frequently used as the trigger before an increase in the price. Its purpose is to shake out stops and pick up cheap volume prior to the price being marked higher.

As can be seen from the above two examples, price can move very rapidly in the current market and is instigated often by high frequency traders. These are only two examples of the hundreds that can be found on the ASX.

While this represents a grave threat to the uninformed investor, to the informed investor it represents an incredible opportunity. If the market manipulators change the price of an instrument in repeatable ways, then this can be used to the advantage of informed and educated traders. Currently, market manipulators do manipulate the price in a recognisable manner. Therefore, if a trader works in harmony with them, the trader can enjoy the benefits of the manipulations, instead of having their stops hit just before the price is marked up.

Michael Brook – Trading State



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