Managing Director, Head of Research, AbleMarkets.com
Yesterday, May 4, 2022, the markets eagerly awaited and then vibrantly celebrated the U.S. Federal Reserve decision. The Fed raised the rates by 0.5%, the largest raise since 2000, and the Dow Jones index went up by 2.97% from 11:30 AM to 4 PM. The S&P 500 ETF NYSE:SPY alone went from $414.29 at 12 PM Noon yesterday to $429.06 at the 4 PM close, registering a 3.56% gain.
Figure 1. AbleMarkets tweet from May 4, 2022, 11:56 AM.
At AbleMarkets, however, we saw a less exuberant picture. As we posted on our Twitter around 11:56 AM yesterday (please follow us @ablemarkets, link to the tweet: https://twitter.com/AbleMarkets/status/1521881391729987584, also shown in Figure 1 ), institutional investors such as pension funds and large hedge funds were significantly negative about the state of the markets and were net selling the U.S. markets. Aggressive high-frequency traders (HFTs), those HFTs that thrive on fast reactions to news, just started to net buy the markets at that time. The pattern continued until about 1 PM, when the institutions switched to net buying, but not before a deep sell at around 12:30 PM. Ditto for the HFTs, who reluctantly participated in the buy extravaganza late that afternoon, as Figure 3 shows.
Figure 2. Net Institutional flows for the S&P 500 ETF (NYSE:SPY) on May 4, 2022, the day of the most recent Fed announcement.
Figure 3. Net AHFT flows for the S&P 500 ETF (NYSE:SPY) on May 4, 2022, the day of the most recent Fed announcement.
As we have discussed in Real-Time Risk: What Investors Should Know About Fintech, High-Frequency Trading and Flash Crashes by Aldridge and Krawciw, Wiley, 2017, the U.S. stock (equity) markets have three main groups of investors:
- Institutional investors that represent large professional investors with billions under management
- High-frequency traders and broker-dealers deploying high-frequency strategies in their intraday execution of orders sent (mostly) by the institutional investors. The institutional orders tend to be large and more complex, and therefore require advanced quant strategies to make them blend into the market flows as much as possible.
- Retail investors: casual investors, “mom-n-pop”, self-guided individuals and also often those guided by many financial investment advisors.
The institutional investors tend to be highly educated, sophisticated and have access to the best research. As a result, the institutions tend to have a high “win ratio”: the ratio of the number of trades they win to the number of the trades they lose. Institutional investors also tend to have long investment horizons, for example, quarters or even years. Institutions are also characterized by large trades: since they are managing billions, it would make sense for institutions to buy and sell in million-dollar positions. Such turnover typically takes several days to complete to minimize market disturbances (imagine what the market could infer if someone sold US$1 billion of IBM stock in one day? – surely, the shares would plummet significantly).
The aggressive HFTs are driven by fast news changes, tend to trade smaller lots, and are often at the beck and call of the institutions. As such, the HFTs also benefit from the top-of-the-line research and convey that very research to the markets.
The retail investors, however, tend to rely on the less educated media forecasts and are often considered to be gambling in the markets.
Figure 4. Institutional trend for the U.S. markets using NYSE:SPY as a market proxy.
Figure 5. Recent net Institutional flows for LUMN.
Figure 6. Recent net Institutional flows for FBGI.
At AbleMarkets, we systematically and continuously parse the daily flows and pick out the institutional and HFT activity. Once we identify the institutions and the HFT, it is easy to spot retail: the trading flow left. For the curious reader, a lot of the methodology we deploy is discussed in Real-Time Risk: What Investors Should Know About Fintech, High-Frequency Trading and Flash Crashes by Aldridge and Krawciw, Wiley, 2017, and also High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems, by Aldridge, Wiley, 2013. Throughout, we stay on top of Mathematics and Statistics and use the most advanced data science techniques like the ones we described in Big Data Science in Finance, by Aldridge and Avellaneda, Wiley, 2021.
Where do we see the markets go from here? Due to the nature of their long investment horizon, institutional flows, once detected, tend to predict markets for months, quarters and even years to come. Overall, we see the institutions to be slightly negative on the U.S. markets (Figure 4), but bright spots remain. For example, stocks like LUMN (Figure 5) and microstocks like FBGI (Figure 4) have all registered positive interest from institutional investors. Please visit AbleMarkets to find out more!