With our recent discussions on HFT and how much the game is rigged, along with many other articles across the internet, there’s plenty of fodder to ponder regarding algobots and what goes on behind the scene. A private trading forum recently had a discussion regarding this very thing. What was so instructive was the level of expertise involved in the discussion.

These aren’t your run-of-the-mill traders. A lot of these folks are pros who make their living doing this. Many manage huge accounts. A few have close ties to Wall Street. So, when these guys give us a peek of what’s going on behind the curtain, it’s a good idea to take notice. This particular trader didn’t want his name divulged, but agreed to let me post his thoughts.

General market thought – clearly the market is quietly falling apart. The headline numbers don’t yet reflect it, but it’s there. “They” say the volume isn’t relevant anymore (remember – it’s always different this time – except until it isn’t) and will go on CNBC to spout off 10 different contrived facts as to why in order to satisfy their reasoning. Those are the money managers who make a living off of your 2% commission on invested funds (not on returns!) who so desperately need you to believe in the ‘buy and hold’ or ‘hold and hope’ so as to not want to pull your money, thus lowering his standard of living.

The SPX is the benchmark to which all professional money manager’s performance is ranked. If the SPX goes up 4% in a year and your account goes up 5%, well, he beat the market and you get a nice sales pitch at the end of the year to convince you as to why you need to stay with him. If he does 2% then you’ll get the same sales pitch with all kinds of excuses that are designed to sound far more sophisticated than you’re most likely (and hopefully for them) able to grasp. Again, keep that account to maintain that 2% fee!

But something is happening. Up until the 1980s, most money managers or stock brokers made middle income livings. They didn’t have access to crazy leverage or futures (other than commodities) and options were something new and not very well understood or even able to be done by most. It was strictly stock picking. Very strict laws were put in place in the 1930s to stop reckless behavior by banks and investment firms. Glass-Steagall was the main one that basically separated traders from bankers. Even though it wasn’t repealed until 1999 which arguably led to today’s mess on Wall Street, it was openly violated in the 1980s which, among many other things like the Germain Depository Act that would take far too long to explain here, led to the late 1980′s savings and loan collapse which was the precursor for today. But throughout all this, one thing kept Wall Street VERY profitable. Trading. It’s no more complicated than that.

But how, when it’s been said that over 90% of active traders lose money, do these firms make so much? It’s simply like Vegas. The House ALWAYS wins. Why? Because they have the most money. But if you had all the money, you couldn’t control the market like a Goldman or Lehman or Bear or JPM can. Why? Because you and I have to file 13ds to tell the world we’re buying up large %s of stock. They don’t! How? They’re classified as ‘Market Makers’, and thus is order to make a market they have to have ‘inventory’ of stock to sell in order to make a market. That is the scam. They have no problem colluding with each other on these trades where they are able to control a large % of the stock’s float. I can prove it –

Look at the old guard tech giants — MSFT, INTC, CSCO. Those companies all have between 4 and 7 BILLION shares in their floats. Even DELL has almost 2 BILL. Wonder why no one trades those? They NEVER MOVE! Traders (large Wall Street firms) can’t make money on a stock that trades in a .20 range a day!

Now look at the ‘high flyers’ – AMZN, PCLN, CRM, CMG – Most are around 100 to 200 mill shares with CMG at only 30 MILL SHARES! Wonder why that stock moves sometimes in $10 daily ranges? It’s a trader’s wet dream. It’s the same reason why FB is such a POS – 500 MILL shares at IPO with nearly 2 BILL coming to market when the insiders are able to sell! Who wants to own THAT?

But back to the point – look at the volume in the market. Wall Street firms only make money taking it from you and I. But over the last few years you and I (well, not us!) arent’ buying their BS anymore and have taken our money elsewhere. Now, these firms have all morphed into these hybrid trading networks that only make money on per-share commissions like Knight and BATTS. With volume so low and getting lower and lower with only the large volume days on the SELL days, both these order flow firms and the trading firms are left with…? They are basically trading to each other. Their computer ‘algo’s’ are buying and selling probably their own trades!

The banks have gotten into this game too. But again, it’s a very crowded field. I have a very close friend who works on the Street who tells me there is carnage going on on these trading desks. If it conitinues, or continues to get worse, come next year around 1st quarter or 2nd Q earnings, these banks are going to be seriously in trouble because it’s really one of the last areas they have that are profitable. This mortgage backed stuff the fed has created which is allowing the banks to make the .5% spread on Fannie backed mortgages will last only so long. The bond market is quietly waking up and is going to put a big stop to that.

I can’t express how important this information is. The discussion continued with some more invaluable info that I’ll try to put together later. Interestingly, this came out as I’m in the middle of studying the recent ruling by a federal appeals court that displaces customers of banks as first to receive returns of money lost in the event of a failure. It’s a complicated issue, so I’m trying to make sure I get my facts straight. But we’ll visit this as soon as I can grasp it.

For your prosperity,

J. Keith Johnson
The Gold Informant