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Last Thursday, September 6, news came out before the Open that the European Central Bank would be buying the debt of troubled Euro-zone countries -- and the equities markets sky-rocketed on the news. It is said that the market hates uncertainty, and the uncertainty coming from Europe (that could drag down the U.S. economy) went down a lot with this news. The S&P mini's went straight up nearly all day on one of the biggest single-day moves of the year. You need to understand what's going on in this situation, besides the obvious.

 

The first thing you need to know is that big players move the market, not small players (like us). When I buy 2-4 contracts of the S&P mini's, that doesn't move the market. But when Goldman Sachs buys 500 or 1000 contracts, not only will that move the market, but it gives a big signal which direction they think the market is headed. And when lots of big players are all on one side of the market, you get a day like last Thursday.

 

When the market reacts like this to news, it's because the big players know the news will have a big effect, and that makes current prices suddenly very out-of-line with reality. So on Thursday they loaded up, and loaded up big.

 

The thing I want you to learn is this: even after such a strong move up, the market is probably still not in line with reality and will usually keep going up. The way the market reacted on Friday is confirmation: the market moved sideways all day then went up in the last few minutes before the Close. Someone out there thinks the S&P mini's still has room to go up.

 

This happens all the time in the stock market when a company announces much better-than-expected or much worse-than-expected earnings -- on the news a stock will have a big move up or down, respectively. For example, on August 15, 2012, NetApp announced better-than-expected earnings and the stock has gone up about $5/share (more than 15%) in the past 3 weeks -- see chart below. Notice the accompanying volume spike of about 3 times normal volume as the big players loaded up on the stock.

 

netapp1.PNG

 

In addition to the news from Europe, we may also get QE3 stimulus from the Federal Reserve. They say that the Fed chairman is politically independent, but I don't believe that for a second. Any sitting President of the United States will put any kind of pressure he can on the Fed Chairman to increase stimulus, which will help him get re-elected. You think that's going on in a tight election year like we have this year? You can bet the house on it.

 

Put these things together and it shows the equities markets can still go higher from here.

 

Many Profitable Returns,

 

 

Trader Gregg

 

Mr. Killpack has been studying the markets since 1988. He has read over 40,000 pages about trading and investing strategies, fundamental and technical analysis, and related topics. He began day trading in 2001.

 

TopstepTrader http://www.topsteptrader.com seeks to find and develop undiscovered trading talent from around the world. While in our program, those who display a strong trading skill and aptitude will be backed as a fully-funded trader.

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The first thing you need to know is that big players move the market, not small players (like us). When I buy 2-4 contracts of the S&P mini's, that doesn't move the market. But when Goldman Sachs buys 500 or 1000 contracts, not only will that move the market, but it gives a big signal which direction they think the market is headed. And when lots of big players are all on one side of the market, you get a day like last Thursday.

 

Does the S&P mini move the "Market" or does the market move the S&P mini? I thought the S&P mini's (ES) was indexed on the "Market". I thought that the ES does whatever the S&P 500 does?

 

What if Goldman Sachs buys 500 or 1000 contracts of the ES, but the S&P 500 Volume goes negative? Who is right and who is wrong? If Goldman Sachs buys a massive amount of S&P STOCKS (Not e-mini contracts) and that in turn drives the S&P 500 up, and that in turn causes the ES to go up, that seems like the way it works. Maybe I'm wrong?

 

Maybe the ES can affect the S&P 500 and vice versa, but I thought that the ES was an index based on the S&P 500, implying that the S&P 500 drives the ES and not the other way around? But I don't know that I've ever gotten a definitive explanation from somebody who has inside knowledge of how the exchanges work. Anyone can tell me that the big players move the market, and it makes sense, but I'm looking for something a little more detailed than that.

 

I'm not sure than any retail traders (No matter how many years they've been trading) actually know the answer to this question. I wouldn't be surprised if the exchanges have there little secrets that do NOT get released to the public.

 

Again, what if Goldman Sachs buys 500 or 1000 contracts of the ES, but the S&P 500 Volume goes negative? Just because an institutional investor goes big doesn't always mean they are right. If the ES can NOT move the S&P 500, and the ES is almost always in sync with the S&P 500, then Goldman Sachs could buy 500 or 1000 contracts of the ES, but if the S&P 500 goes down, it's not going to be long before the ES goes down no matter how many ES contracts were bought. And all those ES contracts bought will be losers.

 

There is a distinction between the volume of the ES, and volume of the S&P 500. They can be in synch, out of synch, or partly in synch. They are two different things. There can be a spike up in ES volume as the S&P 500 volume is going down. I compare the two.

 

If anyone can definitively answer these questions with some kind of inside knowledge of how the exchanges operate or references I'd sure like to know.

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Tradewinds - in answer to your question you need to understand stock index arbitrage.

It is relatively simple, and it basically results in the ES and SP500 (the derivative and the underlying ) in being highly correlated.

If does not matter where the buying or selling originated from - there are other players trying to exploit discrepancies in fair values between the two.

Remember - one is a derivative (its price is derived from) the other.

Some instos are not allowed to buy futures, others use them purely as a hedge, some insto are long only, some are futures only, some people are hedging with the 'bext value' instrument available at the time, others are spreading various equities markets..... You need the arbitragers and speculators as well in a market.

(plus when you talk about volumes going negative I assume you are saying volumes decline, relative to previous volumes or the other instrument volume?)

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The 500 stocks in the s&p 500 are what moves the SPX and ES.

 

The s&p index (SPX) is calculated by getting the market cap of each stock and then weighing each share price by the weight of its market cap to the other 500 stocks. A rise in the price of the stock will increase the index by that percentage increase times it's weight if no other stocks had a change in price. In practice the plusses and minuses created by buying and selling stocks make the moves minor per each stock unless there is mass buying or selling.

 

It could be that speculators buy es anticipating a move and es moves more than the index. When arbs recognize this they will sell es and buy the underlying to take advantage of the opportunity. This is not to say that the speculators are always wrong when the big bad arbs, step in. Arbs could sell es and buy stocks while the underlying stocks rise and es continues to rise until the discrepancy disappears; es and stocks could both rise at a different rate. But, the speculators could be wrong too and a slightly different situation would prevail until the discrepancy disappeared.

 

There are also arb opportunities between options, interest rates, and volatility on each of the indexes, underlying sectors, stocks, futures, swaps, and you name it. Each could have an impact on the instrument and then the index. Ultimately, someone who owns the stock will look at the price of the stock relative to the current and future earnings potential and decide if it is overvalued or undervalued.

 

In the end, earnings and potential earnings are what drive stock prices and the S&P.

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If does not matter where the buying or selling originated from - there are other players trying to exploit discrepancies in fair values between the two.

 

Thanks, I appreciate the explanation.

 

That makes sense. People on all sides of the transaction looking for opportunity. Short term, (Minute by Minute) it's probably whatever side of the transaction has more activity. Someone could see that 1000 contracts of the ES were just bought, and decide that the 'best value' instrument available at the time, would be to buy a stock rather than the futures contract. That would result in more buying volume of the stock at the same time the ES volume is going up.

 

Probably if I understood options and hedging I'd be able to have a more complete understanding. Basically, if someone sees that 1000 contracts of the ES were just bought, and there is relative less buying activity on the SP500, someone is going to attempt to take advantage of that discrepancy. For the buyer of the 1000 contracts, at some point, they need to get out of that transaction. Someone has to be on the other side when they want to get out. So someone is going to try to be there on the other side when they want to get out, hoping they will make money. And I'm assuming there are multiple ways to do that.

 

I'm just guessing here. I'm assuming that's the way it happens. The extent of my understanding is just trying to absorb information here and there. Is there a good book, or article, web post that explains the basics of how different instruments interact to each other?

 

Probably plenty of books on strategy based on some indicator, but I'd like to know a simple overview of all the instruments and basic tactics.

Edited by Tradewinds

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The s&p index (SPX) is calculated by getting the market cap of each stock and then weighing each share price by the weight of its market cap to the other 500 stocks. A rise in the price of the stock will increase the index by that percentage increase times it's weight if no other stocks had a change in price.

 

Thank you for your response.

 

Is the market cap being constantly updated second my second? Is there any way to get that info in real time? In other words, do exchanges and/or brokers provide that kind of data? If that is the way the indexes are calculated, then someone must have that data and be using it second by second? Would I need to be feeding data from all 500 stocks into a spreadsheet and calculating the formula myself? I'm trying to understand how the calculation for the index could be used in real time for actual trading.

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tradewinds - you are complicating it.

There are participants in the market that arbitrage between the fair value of the futures v the basket of the underlying instruments. They will not care if someone is buying 1000 contracts of the futures - they will care if the price moves above or below their fair value, and more than likely if there is an opportunity they will be selling the futures if they are 'overpriced to the basket'

There are no magical indicators in use.

There are no options involved (options hedges may be involved in the initial buying but are not involved in the stock arb)

Re: market capitalisation....google it - it is a basic of stock markets, and the various stock indexes around the world are made up in various manners....you should not need to calculate it all the time, and if you want to try and use the calculation of the index for trading you will be competing against the arbitrage groups and HFT.....probably not worth your while as fees and speed would kill you

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Thank you for your response.

 

Is the market cap being constantly updated second my second? Is there any way to get that info in real time? In other words, do exchanges and/or brokers provide that kind of data? If that is the way the indexes are calculated, then someone must have that data and be using it second by second? Would I need to be feeding data from all 500 stocks into a spreadsheet and calculating the formula myself? I'm trying to understand how the calculation for the index could be used in real time for actual trading.

 

Track all 500 stocks, calc the market cap, weigh them and then compare that to the index or es. A lot of the arbs try to use a representative basket of stocks that will mimic the index. At least this is what they used to do. It's a game that is dominated by institutions who have lightening fast execution (HFT)

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