Are Commodity Markets Manipulated?
August 1, 2005
p>No matter if you have been around the futures industry for a week or 10 years I will bet that a majority of you have heard rumors from other brokers, books, or even trade magazines to the effect of, "Are commodity markets manipulated by a handful of 'big boys' worth hundreds of millions in NY or Chicago, who manipulate the markets to 'shake out' the small traders and blow up the stops?". The question above is from an e-mail that we recently received from a current customer who found it important to ask…I'm sure many of you have thought the same.
The goal today is simple; let's get to the bottom of the rumors to find out if and how they affect your trading system investments.
Are Markets Manipulated?
Many of you will agree that this is a loaded conversation so I will try to stick to the facts. Let's first define manipulated in this context - To tamper with or falsify futures or commodity prices for personal gain. Although it does occur, to manipulate the market is very illegal and can result in large fines and or jail time…just look at Bernard Ebbers (Former WoldCom CEO). The WorldCom scenario is a much larger scale problem than we are attempting to deal with today; the comment above is referencing the day to day markets and thinking that large traders will purposefully or knowingly attack given prices (aka "your system stop") in order to quickly turn a profit at smaller investor's expense.
Is there any potential gain in such a strategy? Does it make sense to sell hundreds or thousands of contracts - at a risk of hundreds of thousands of dollars - just to run the market to a systems stop price?
To examine this theory we went right to the market (the pits at the CME and NYMEX). First it is note worthy that each commodities exchange in the world has a set number of contracts that one individual trader, fund, or CTA can hold at any one time, this is referred to as position limits. For example one trader can only hold 4,500 net positions in Cotton, 10,000 positions in the Euro Currency, and no more than 20,000 S&P or Crude Oil futures at any one time. I highly doubt that it is in any large funds long term strategy to push these limits on a daily basis in order to pick off a few stops.
Secondly we created the chart below to better articulate the level of risk any investor holding 50, 100, and 200 contracts of the Full Size S&P futures, the e-mini S&P futures, and the Crude Oil market (assuming today's closing prices). Risk is determined by multiplying market price x market point value x number of contracts (i.e S&P = 1237.50 x 250 x n). Although many short term speculators will enter into trades and exit them very quickly there is still a great deal of risk that goes into entering any one trade hence the question of if it is work the risk in order to run a system stop.
Assuming that large volume trades are not a part of many if any investors daily regiment, what are people talking about when it comes to market manipulation? What most brokers, trade articles, etc are talking about is big traders or locals who attempt to stimulate buying or selling into psychological and or technical trading levels. For example a pit trader sees the S&P trading @ 1239.70 and starts buying 5 lots or 10 lots in an effort to start some buying interest in attempt to push prices above 1240.00. Last week 1240.00 was the previous 2005 high in the S&P and a natural spot for anyone holding a short position to place their stops; so once the market pierced 1240, the buying triggered by stops being hit caused the market to run up to 1241.70. These locals started unloading their positions the minute the market moved above 1240 and the market naturally sold off quickly back below the 1240.00 level.
This type of activity is as old as the markets themselves, and is just part of trading. I would not call it manipulation, because the locals are just "trying" to push prices higher. A large Hedge Fund or Mutual Fund Company, etc could come into the market at the same time they were trying to move it up above 1240.00 and sell thousands of contracts, causing the local to quickly get out of the long positions for a loss.
I am 100% certain that Merrill Lynch or Morgan Stanley are not looking to run the market in this context but rather have their own agendas for making money or at the very least hedging their existing long stock positions, so again there is a great deal of risk on the local the rest of the market will be against his scrupulous intentions.
Although we cannot speculate on the exact trading practices of any large market player at any give time of the day we do know from experience that from a technical perspective traders love round prices (i.e 1235.50 or 1230.00), market highs (i.e 1240.00), market lows, etc and that when the markets are trading at or near these technical levels we can expect there may be an interest by one ore more parties to interest the market in getting there.
From a trading systems perspective a majority of the systems we trade utilize a "fading" technique…in Lehman's terms the system developers have been made aware of the fact that markets will trade to even prices and as such will purposefully adjust the stops of the system away from the market to odd prices (i.e 1235.40 or 1229.90) in order to ensure they are not sitting on one of those "psychological levels" on a regular basis. Although I do not have the proof that the technique works, I can vouch from experience that it has saved many a system from a sure fire loss many a time...and even if it works once it was worth the developers work for every penny saved.
Thanks for the e-mail Howard…If anyone has a specific comment or question they would like to see addressed personally or in one of our newsletters please e-mail us at invest@attaincapital.com.
Jeff Eizenberg
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can
carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for
everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading
losses are material points which can adversely affect investor returns.
Feature | Week In Review | Chart of the Week |
Feature | Week In Review | Chart of the Week |
July was a great month for the US stock market with the majority of SP 500 components reporting positive earnings for the second quarter. Stocks shrugged off nearly every obstacle in their way including another ¼ point rate hike by the Fed, the revaluation of the Chinese Yuan, rising crude oil prices, and another massive hurricane that hit the US coast. NASDAQ futures were the biggest mover gaining +8.22% as tech companies continue to outperform the market. SP futures gained +4.30% behind strong earnings from stalwarts like Exxon, while both the Russell 2000 futures at +6.45% and the SP Midcap 400 futures at +5.21% traded at all time highs at various times during the month.
Energy prices continued to rise in July as record breaking temperatures across the U.S. had many people cranking up the air conditioning. Production disruptions from Hurricane Dennis also played a role in a month that saw crude oil futures gain +3.95%, natural gas futures gain +9.55%, and unleaded gas futures gain +12.82%.
The long anticipated sell off in the US Treasury markets finally happened in July as well. The de-pegging of the Chinese Yuan from the US Dollar to a basket of currencies has led many to speculate that Chinese investment in US bonds will slow. The Chinese have been amongst the largest buyers of US debt and many have speculated that this bullishness led to the flat yield curve conditions we are seeing today. For the month 30 year US bonds were down -2.03% and 10 year notes were down -1.61%.
Surprisingly, the foreign currency markets barely moved despite the un-pegging of the Yuan. On the day of the announcement there was a brief pop in the Eurocurrency, Swiss Franc, and Yen markets but for the month the EC and Swiss remained nearly unchanged since June. The Yen did sell off falling -1.41% but the Dollar Index also remained flat.
Grains have been choppy to say the least as growing conditions remain marginal. For the month corn futures rose +8.13%, Soybean futures gained +4.80%, and wheat futures remained unchanged. In New York sugar futures gained +5.95%, while cotton lost -8.21%.
*Day Trading**
An S&P futures chart for the month of July looks like prices are headed straight to the moon. Despite the run-up in the equity markets, day-trading system performance was mixed as many systems were betting on a pullback off the highs that never really surfaced.
The one family of systems that dominated the conditions in July was BWT, both in the S&P and Emini Russell markets. BWT Zones SP was the top producer in July, bringing in $3,445 in profits. BWT Rock N Russ was next in line, making $3,129 per money management unit using the position manager. Right on its heels was BWT Zones Russell, which made $2,752.30 per contract.
Elsewhere, Compass and Clipper (both by Mariner Futures) both had strong showings in July, profiting $1,756.60 and $470.40 respectively. Impetus eRL flat-lined in July after a strong June and was slightly profitable by $61.70 per contract.
Other systems weren't able to capitalize on the bull-run in July. RC Miracles was relatively quiet for the month, but lost -$47.50 per contract. Day Breaker SP was similarly quiet, and was unprofitable by -$107.50. RC Success lost -$237.50, its second consecutive losing month after making new equity highs in May. Nautilus ES, a new system by Mariner Futures, lost -$312.50 on a handful of trades. The system is significantly different than Compass and Clipper in that it will enter trades much earlier and generally jumps into a trending market rather than waiting for a retracement to enter trades.
The Electric Day Breaker portfolio lost -$342.50 trading all four markets. Helix ES had a tough month, losing -$1,143.75 per emini. R-Mesa fell deeper into drawdown in July losing -$3,930 on twelve trades. AG Xtreme struggled with the low-volatility conditions as well and was unprofitable by -$3,950.
**Swing Trading**
Swing traders were quiet in July and only a handful of them were able to capitalize on the run to the upside.
Of those systems, Axiom eMD was the top performer with profits of $1,756.60 including closed and open trade profits. The system had two small losing trades before the getting into the long trade it has been holding since July 7th. Axiom NQ's chart in the month of July was more pleasing to the eye as it made $1,600 on two trades. The first trade was a short trade initiated in June and exited early in the month. It did give back some open trade profits early in the month before exiting the trade and reversing to long. On the long trade, it went on to hit its windfall profit target of nearly 100 points.
Athena eRL is new on the scene and profited $940 on two trades. Athena is the sister system to Apollo ES which profited $775 on two trades in the month -one short and one long trade. Tzar ES was making $832.50 per contract at month end including open trade profits (losses in this case) on its current short trade. Eclipse was on fire to start the month but ran into a few roadblocks to close the up just $154.20 per contract for the month. Axiom ES traded twice, once for profits and the other a loss for a net loss of -$690 per contract. Axiom eRL stayed out of the market for the entire month of July. Tzar eRL and NQ both lost -$950 and -$1,680 including positive open trade profits on their current long trades.
Mesa Bonds and Notes traders were not happy to see bond prices tumble in the month of July. Mesa Bonds lost -$3,820 in open and closed trade profits after exiting a long trade and re-entering long a few days later. Mesa Notes continues to hold long and was down -$2,484 in open trade profits (losses).
**Long Term**
Long term trend followers have not had much to cheer about in 2005. Much like last year '05 is shaping up to be a tough year for longer term systems. However, investors should remember that it was in the third and fourth quarters of last year where most trend followers had their biggest gains. One can only hope history repeats itself this year.
As for July choppy market conditions in the grains combined with the end of the bond market rally caused most systems to post negative returns. Andromeda may have been hit the worst as the system was stopped out of positions in palladium (-$170.00 per contract), US bonds (-$225.50 per contract), US 10 year notes (-$272.00 per contract), corn (-1087.50 per contract), and cotton (-$1205.00 per contract). However, the secret to trend following is to take the small losses and let profits run. Profitable trades of note for Andromeda includes +1975.00 per contract in the Dollar Index and +$2312.50 per contact in high grade copper.
Aberration Plus and Axiom LT also took their bumps with Aberration losing -$2162.50 per contract in the 10 year notes, -893.75 per contract in the 2 year notes, -$2745 per contract in cotton, and -$1850 per contract in the Aussie 10 year notes. Axiom lost -$3350 in natural gas, -$1020 in palladium, and -$1890 in live cattle.
Both Aberration Plus and Axiom have performed well in the currencies with Aberration Plus making +$1660.00 per contract in the dollar index and +$1587.50 per contract in the Mexican Peso. Axiom LT is short in the Japanese Yen for profits of +$6281.25 per contract, short in the Swiss Franc for profits of +$3475.00 per contract, and long in the dollar index for profits of +$1975.00 per contract.
Finally, SEMA4 Symmetry had a quiet month as it was only stopped out of cotton for a loss of -$1200.00 per contract and corn for a loss of -$1237.50 per contract. SEMA4 Symmetry is also holding long in the Dollar Index for profits of +$170.00 per contract.
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IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can
carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for
everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading
losses are material points which can adversely affect investor returns.