The Featured Trading Advisor Commodities
Trading Article of the Month
Gunning for Stops Can Claim Victims in
the Commodity
Futures Trading Pit
It's
a few minutes before commodities futures trading closes
on The New York Commodity Exchange one afternoon,
all hell broke loose. Another of the many trading
games commodity traders play was underway.
In the
Cooper Futures trading pit, a sudden surge of copper
buy orders arrived in the trader pit on the trading
floor. Normally such late trading activity barely
moves the-futures price. But on this trading day,
so many large commodities traders left early for the
London Metal Exchange's gala annual dinner that there
weren't many copper futures sellers around to accommodate
the copper futures buyers. Copper prices soared nearly
3-cents a pound, which is a comparatively large size
price move.
The
few junior traders still at their trading posts quickly
concluded that someone was trying to exploit the market's
non-attention to move cooper futures prices about
$1.07 a pound, a technical price area deemed crucial
by traders who use technical analysis of the market.
A price move above $1.07, it was widely assumed, would
trigger "buy" signals amount trend-watching
commodity funds, prompting the automatic execution
of a heap of standing orders from off-floor traders
who earlier placed standing orders to buy on a buy-stop.
Such
ahead-of-time orders are known as "stops,"
which is why this game is called "gunning for
stops." The idea was to induce a flood of buying
above $1.07, whereupon cooper would soar even higher,
at which point the trader who started the game could
sell out at a profit.
This
trading game probably fails more often than it works,
traders say. In this case, the price touched $1.07,
but didn't rise any further; it fell back a penny
at the close. That's the risk people run in gunning
for stops, traders say. Yet the game can pay off handsomely,
and it is much in evidence in many of today's commodity
markets.
Gunning
for stops can work because so much commodity futures
trading today is based on trading-systems which use
widely available commonly used technical indicators
such as moving averages and momentum trade algorithms
with authoritative sounding technical names such as
relative strength and stochastics. In some cases,
traders can guess from market talk and by looking
at price charts where the key levels are. And they
know that traders usually place buy-stops or sell-stops
around those critical areas.
Money
managers and other futures traders and home-based
day traders have complained privately for years about
floor traders engineering price movements to trigger
stops and computer-generated signals to buy and sell.
But in this and other cases recently, they suspect,
very large players were trying their hand at the game.
If so, they say it is a disturbing development. "This
is a very controversial issue," says one commodity
futures money manager. We're very, very unhappy about
it."
Who
gets hurt by traders playing the game? Anyone whose
stop was triggered artificially. Those people may
be forced to take profits too early, sustain losses
they wouldn't otherwise incur or take positions based
on false price signals, traders and analysts say.
And when those traders are money managers, their investors
get hurt. Technical traders are particularly vulnerable
to getting whipsawed by these short-term price swings,
says Fred Demler, metals economist at PaineWebber
Group Inc.
Sumitomo
Corp's Yasuo Hamanaka later confirmed he had placed
buy orders at the end of the 10-8 session, but denied
they were speculative. Mr. Hamanaka has a reputation
as an aggressive trader. He made similar denials -
met with skepticism - when he was rumored to be behind
squeezes in the London Futures Market the prior year.
In recent
years, Middle Eastern syndicates are thought to have
used the gunning-for-stops strategy in precious metals
markets. And some people think big U.S. commodity
futures trading funds have figured out how to profit
either from riding the coattails of other players
using the strategy or by doing it themselves.
Traders
won't admit they gun for stops. And regulators say
it's next to impossible to prove that a price move
was the result of manipulation, which is illegal.
But few people in the market deny that it goes on,
and some say they've noticed it occurring more frequently
in the past year.
"It
happens all the time," says a sugar trader. Recently,
he adds, he's seen more investors "getting stopped
out" by a sudden-moving market that triggers
their stop orders. That could simply be the unorchestrated
result of a choppy, thinly traded market, he says,
but people are blaming traders for gunning their stops.
"When
it's happened to me, I've been extremely angry,"
says George Milling Stanley, a precious metals analyst
at Shearson Lehman Brothers. Trade recommendations
he has made to individual investors have lost money,
he says, because traders went gunning for stops. For
example, suppose he thinks gold prices will rise and
recommends clients buy it at $335 an ounce - adding
that they should put in a stop-loss order at $333
in case he is wrong. Then suppose some traders gun
the market down to the stop levels, which sells the
investors out of their positions at losses, and the
price subsequently rises above $335 as originally
expected. "You feel like someone's stolen the
march on you," he says.
Jeff
Nichols, a Boca Raton, FL, precious metals consultant,
says a well-capitalized floor trader can occasionally
pull off such a move in small, thinly traded markets,
particularly if other traders sense what's going on
and join in. But in larger markets, such as currencies,
it takes a lot of money to gun for stops successfully
because the player has to be able to buy or sell contracts
in significant quantities, Mr. Nichols says.
Well-known
commodities trader Richard J. Dennis says he tries
to anticipate where technical traders have placed
their stops and gauge the effect that activation of
the stops will have on prices. "If you look at
charts, you can make a reasonable guess about where
the stops are," Mr Dennis says, adding that he
uses this information to avoid those areas. "They're
a little bit like land mines going off, and you don't
want to walk into the mine field."
Some
Wall Street "rocket scientists" have honed
the guesswork more precisely. They are able to identify
which technical system is prevailing at the moment
and what signals the system will give out at different
price levels, Mr. Nichols says. These sophisticated
traders then use that insight to devise trading strategies
accordingly, he says.
One
futures money manager thinks stop-gunning traders
neither guess nor use computers, but instead are learning
through their brokers and other sources where the
big orders are sitting. "I wonder if this were
the securities industry, if (traders who gun for stops)
wouldn't be in jail for this type of thing,"
he says.
Brokers
who disclose such information would be violating federal
regulations and exchange rules. But there are more
subtle ways the information leaks out, traders say,
such as through winks and nods and euphemisms. "They
don't come out and say "I have an order at six,"
says a former New York trader. "They say, I think
there's good resistance at six."
In the
crowded trading pits, traders can also find out about
stop orders when they catch a glimpse-accidentally
or intentionally-of other brokers' order cards, says
an analyst. Because they have little hope of a regulatory
crackdown, gunning victims say they have learned to
accept it as just another risk in trading commodities.
"If you want to play with the big boys, that's
the way it works," Mr. Nichols says.
To avoid
being stung, many money managers no longer place resting
stop-loss orders, says Jane Martin, executive director
of the Managed Futures Association. Other futures
market players, says Mr. M-Stanley of Shearson,
have learned to protect themselves by placing stop
loss orders further away from the current futures
price level. Experienced traders recommend moving
stops (known as bumping stops) when activity looks
suspicious. Trading market users must be especially
alert during slow-trading periods, such as during
banking, international or religious holidays, says
Mr. Demier of Paine Webber.
Still
others try to take advantage of the trading strategy
without actually playing it. M. Pinson, partner
of Fundamental Futures, an Iowa money-management firm,
says her futures trading firm watches for such things as gunning
stops for opportunities to execute trades it would
have made anyway. "We have learned to wait until
the technical traders stop-loss orders are triggered,"
she says. As the "big machine traders" start
selling futures, her firm goes the opposite direction
and starts buying futures contracts, she explains.
More information on stop-loss methodology
and profit target prices may be found at the Commodity
Traders Club News CTCN.
Reprinted
Courtesy of The Wall Street Journal.
