Thursday, December 30, 2010

Insider Exclusive: How the Game has Changed

Considering it's the end of the year with very little going on in the trenches, I thought to provide my 2 cents on a subject that has really been in the spotlight for the past couple of months:

Insider trading & the related arrests

I suspect the day the Galleon founder was walked out of his Manhattan office in handcuffs will be looked back at as a day the trading game changed.

The investigations following the arrest have shed light to a complex web of (hedge fund) traders, consultants and company insiders buying & selling price-sensitive information about public companies. I'd say that never before has the game been that exposed for public viewing.

Stevie & Raj (1) didn't become billionaires by making random bets on the market. They have consistently been making money for the past 15-20 years. Only now the public is starting to learn how exactly they did it, while most of the mutual funds failed to beat inflation.

But this is not something I plan to whine about. These guys were smart & ruthless enough to take money away from lesser players and that's just how the game works. This is how the really big money is made. Or at least, that's how it was made.

What I'm more interested in is how all this is changing the game.

As many of you may have noticed, I pay a lot of attention to analyst calls. In fact, I'd say most of my trading throughout the day is based on all sorts of (sell-side) analyst commentary. The analysts are paid to guide us traders through the information jungle, pointing out relevant pieces of information & explaining why certain names should move up or down. Their collective opinions are called the consensus. Our job as traders is to constantly compare the current available information against the consensus. If there is a disconnect between the available info & and the consensus an act of arbitrage (a trade!) can be performed.

The (sell-side) analysts have a host of analytical tools at their disposal. None of these tools however, include access company-specific non-public information. RegFD made sure companies can't tell the analysts anything they haven't disclosed publicly beforehand.

So, when using sell-side research as one's guide in trading, eventually Stevie & Raj are going eat your lunch because through consultants, they have access to real-time info.

For example's sake, Stevie & Raj know that despite the fact the UBS analyst thinks Sandisk (NASDAQ:SNDK) is a Sell at 20 bucks in October 2009, NAND demand is actually going to go through the roof as Apple & other are going to unveil a host of products that can't use enough of it.

So, you're left selling your Sandisk (SNDK) shares to Stevie & Raj who are more than happy to buy them. You're left wondering about how the stock recovers the gap-down by noon & ends positive for the day.

By the time the UBS analyst realizes he was wrong & upgrades the stock back to a Buy, it's trading at 32 bucks. You're definitely not going to listen to the chump again as he got it so wrong the last time around. You just sit and watch the stock go up another 10 bucks.

At 45 bucks it's pretty clear NAND pricing is moving up as Apple & others are ordering like mad. Heck, even Digitimes has a story about it. You buy SNDK at 47 bucks. The chart looks great, couple of tier-2 firms are out with positive earnings revisions.

Stevie & Raj are more than happy to sell you your shares back.


Over the next 2 months tech gets hit as rumblings of an Asian component inventory glut make the rounds. Sandisk (SNDK) shares slide to $40 and then to $35.

You sell the first decent bounce at 38 bucks as most analysts are telling you NAND pricing will not recover til 2nd half of 2011.

Stevie buys half your shares but Raj doesn't chip in. He now has other problems...

OK, back to reality.

Most of sell-side research out there is really that bad as exhibited in the Sandisk (SNDK) example. Many of the seasoned sell-siders have moved to the where they can really contribute & make money. This has left us with the 'GSCO kids', barely out of business school to guide us trough our trading days.

But with the recent crack down of the consultant-network-hedge-fund symbiosis, this may be changing. With the consultants pretty much out of the game, hedge fund traders are left to rely on good old sell-side research.

Traders typically pay the sell-side through commish, which means more money will again flow that way. Firms can again hire better/more seasoned people to do research. The quality of research goes up and people will take notice.

Maybe even one day people will look at a Goldman Sachs rating change and say 'Wow, this is good stuff. I wanna buy some at open'.

That I would call C H A N G E.

One can at least hope right?

PS: I spoke to several financial journalists about this subject but I suspect they didn't really understand how big the implications of the recent government crack down could be on the industry. This is really changing the way market participants are dealing with information. And trading as you know is the ultimate information business.

Throughout my career I have noticed (in hindsight mostly) how people have failed to understand or perceive the events that have led to truly big changes. This certainly feels like one of these occasions.


(1) Stevie & Raj are obviously fictional characters portraying large hedge fund players.
(2) Sandisk (SNDK) was picked as an example by entirely random means.


Unknown said...

good story

Unknown said...

Good writing. I like what you write about and agree with your point of view.

Blogger said...

Get daily ideas and guides for generating THOUSANDS OF DOLLARS per day FROM HOME totally FREE.