Trading in Thin Markets

This is a guest post from Tusk Trader, an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader

The markets have been sprinkled with some extra dashes of chaos this week with the melt down of MF Global. Many traders are being dramatically affected if they used MF to clear through. Those traders showed up to work Monday and could not trade. The CME and others are doing what they can to get people back up and running, but it will take time. Volumes at the CME are down 46% week over week in some sectors. That is a dramatic drop. MF Global traded in most international markets but the 46% drop at the CME alone stunned me. That is huge for this time of year. Thin trading is scary enough but thin trading during extreme volatility like we have these days can be scarier than Walmart on the Saturday before Christmas. You take your life in your hands when you choose to partake in adventures like that.

Be very careful in a thin volume environment. Being right on an idea in a thin market can bring some perks with price improvement, but being wrong is awful. When fewer opinions contribute to the process of coming to a reasonable market view on price, you can get whipped around like checked luggage on an Air Canada flight. Once you realize the trade is going bad, there is not always a lot you can do about. It’s awful because in a thin market, the more you try to bail, the worse it gets. The key to light volume trading is to make sure your own trading volume is in step with the market. It sounds simple but when the spread gets wider and you get a few good trades under your belt early, the volume you get involved with always seems to creep a little higher. You start to pick up a little here and little there, and then whammo, you have too much and it starts to go quickly against you. It’s like having the puck on your stick as you cross centre ice with your head down. You don’t even notice you have your head down until it’s too late.

Even if you are not trading directly the CME products, you will notice bigger than normal swings in stocks that follow the underlying commodities and futures traded at the CME (as well as stocks that usually have a large presence in the options market). Gold companies, oil companies, natural gas firms and the like, will all be a little jumpy this week while the MF Global issues work through the system and traders try to get back to work. Keep your trading volume light on light volume days.

Keep your head up.

Thanks Tusk. Make sure to follow Tusk Trader on twitter: @tusktrader

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Showing 3 comments
  • John Buchanan

    An interesting post. Can Tusk elaborate on how the commodities market works and where one can find volume information. Besides MF and CME who else makes markets in commodities

    • Tusk Trader

      Hi John,

      Thanks for the comments. I will do my best to provide some insight. Part of MF Global’s business was to act as a clearing house for a lot of independent traders and investment firms. There is a higher bar set to be allowed to be a clearing firm compared to just an independent trader or investment house. Just being a well regarded investment house does nothing to help you become able to clear your own trades. Although there are costs to clear through someone else, it is much less than trying to become a clearing house. The system is set up this way so that when a trader or firm makes a trade, there is no doubt that the other side of the trade will be fulfilled. The money is booked and the deal is done when you make the trade even if it takes a few days to settle. If you like to have a visual of what the relationship is, think of an old school telephone game where you have a telephone system set up with two tin cans and a piece of string. A trader would have a can, the actual exchange would have the other can, and the clearing firm is the string. When MF went belly up, the string between was cut and the exchange and traders were left to scramble to get some string to connect their two cans again.
      Currently there are a number of firms that act as clearing houses in Canada and in the US. As of today there are a reported 10 firms dividing up the hole left behind by MF. I don’t know off hand know how many clearing firms exist in each country. The CME Group has list on their website of clearing houses they work with. In Canada I would expect the number to be quite low.

      The CME I was referring to in my blog is the Chicago Mercantile Exchange, a major commodity exchange. This is not to be confused with the parent company, the CME Group ( designed just to confuse people) . At the CME, they trade everything from pork bellies to the weather there. Yes, you can buy or short a futures contract on the weather. There are many commodity and futures exchanges scattered throughout major and sometimes not so major centers. In New York there is the NYMEX, in Calgary they have the shiny new Natural Gas exchange. There is the Intercontinental Exchange (ICE) which is primarily based in Atlanta. Some places have open outcry like the CME but not all. The CME Group also owns 4 of them, CME, CBOT, NYMEX, COMEX. Those are the big ones in North America but they are many more in the world in other capital market areas..
      Volume information can be found in a few places. I am lazy and get to see it on my news and charting service. I look at the volume when something like MF happens. This would also be true for a snow storm or other weather event that can affect volume. The CME group does offer daily reporting of volume on their site. They report the volume daily and the changes day to day, plus or minus. The best place to notice it though, is in small paragraphs about the volume shifts that make a quick headline on reuters or bloomberg. Add those two to your news and information list of things that you review. You don’t need to read everything, just scan the highlights for any volume news. I hope that helps and was along the lines of the information you were looking for.

      Tusk Trader

  • dj

    Oh ,Preet just bloged on Gob an Fail,taking advise from online bloggers could be a scam…just kidding, good info!!!