Why Institutional Participation Matters in the Stock Market

Above we can see a chart of SPY (blue line) from 2014 to the present.  The red line represents what I refer to as Institutional Participation.  It is a measure of total upticks and downticks among all NYSE stocks each trading day.  Going back to 2012, if we divide daily institutional participation into quartiles, we find significant relationships.  Specifically, when participation is in its highest quartile, the next ten days in SPY average a gain of +1.72%.  When participation has been in its lowest quartile, the next ten days in SPY have averaged a loss of -.28%.  

 
 

Let’s think about why this might be.

 
 

Suppose we measure institutional participation each minute of the trading day.  To achieve a high reading, we would have to see a great deal of upticking or a great deal of downticking at that time.  In other words, there would have to be broad-based buying or selling among shares–a surge of demand or supply.  Such surges are most likely to come from institutions deploying a great deal of capital, buying/selling stocks overall as an asset class, not just accumulating/distributing shares in a particular name or two.

 
 

The broad accumulation of stocks is associated with momentum–a continuation of price strength.

 
 

The broad distribution of stocks is associated with value–the reversal of price weakness.

 
 

When there is little institutional participation, neither momentum nor value motivations to own shares is present.  Returns are subnormal.

 
 

One of the greatest mistakes I see traders make is focusing on “fundamental” reasons for short-term stock market movement.  This leads to frustration, as many market moves seemingly “make no sense”.  Fundamentals are very relevant to investing, less so to trading.  Trading is about gauging market flows, and flows are not best measured by chart patterns or earnings levels.  In gauging the buying and selling behavior of institutional participants, we can assess whether flows are waxing or waning–which tells us if momentum or value are likely to be drivers of future price action.

 
 

Further Reading:  Institutional Participation and When to Exit

 

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Why Institutional Participation Matters in the Stock Market

Revisiting The New Market Wizards A Quarter Century Later

This is a guest post by Jack Schwager author of the “Market Wizard” series of books.

 

On Revisiting The New Market Wizards A Quarter Century Later

 

Recently, I had the opportunity to manage the process of creating an audio version of The New Market Wizards-a task that was previously handled by publishers for the audio versions of other Market Wizards books. I used ACX, an Amazon platform, to produce the audio. The way ACX works is that you post a short excerpt from the book and invite their narrators to submit auditions. Judging by my experience, ACX’s talent pool of narrators is amazing. In the first few days following my posting, I received about 40 audio audition samples, almost all of them good, and quite a few excellent. I was having such a tough time narrowing the choice down to one that the last thing I wanted was more good submissions. So I pulled the post after a few days. I eventually narrowed the list down from 40 to 4, all of them superb. To pick the final candidate, I did an email poll with 10 industry professionals (e.g., podcasters, traders). To my surprise, one candidate-DJ Holte-was totally dominant, being the #1 pick of the majority polled and the #2 selection of all but one of the remaining 10 respondents.

 

DJ sent me the chapter audios for review one at a time as he completed them. I listened to these audios on my daily walks on the trails of Boulder, Colorado. Besides the joy of hearing my words brought to life by to a talented narrator, this review process exposed me to my own material for the first time in nearly 25 years, raising the question: What had changed?

 

One of my concerns was that, after the space of so much time, I might come across material where my opinion had changed. This project after all was a translation of the original work (from text to sound) rather than a revision. In that sense, it needed to stay true to the original. And yet I thought, What would I do if a passage I wrote decades ago no longer matched my current beliefs?

 

To my relief, I discovered that while many details had changed, nothing substantive had. As an example of one such detail, the futures trading pits, which figured prominently in some of the chapters, no longer exist in the current age of electronic trading.

 

Even accepted science “facts” have changed in the interim. Consider the following exchange in my interview with Victor Sperandeo:

 

Why do you think the majority of people you trained lost money?

 

They lacked what I call emotional discipline-the ability to keep their emotions removed from trading decisions. Dieting provides an apt analogy for trading. Most people have the necessary knowledge to lose weight-that is, they know that in order to lose weight you have to exercise and cut your intake of fats. However, despite this widespread knowledge, the vast majority of people who attempt to lose weight are unsuccessful. Why? Because they lack the emotional discipline.

 

Do you see it? The culprit is the phrase, “cut your intake of fats.” Based on the preponderance of current scientific evidence, there is now widespread acceptance that sugars and simple carbohydrates are the primary villains responsible for obesity and related health problems, not fats.

 

What has not changed since I wrote The New Market Wizards, however, is everything related to trading. Amazingly, or maybe not, I didn’t encounter a single underlying trading principle that I felt needed revision. The only item that I thought I would alter somewhat if I were writing the book today is a comment I made regarding risk control. In the final chapter I wrote, “Never risk more than 1 to 2 percent of your capital on any trade.” Today, I think that this statement is too aggressive. If I were writing this chapter today, I would be more comfortable phrasing the concept as, “Ideally, target keeping your risk per trade to a fraction of 1 percent, with a maximum risk level of 1 to 2 percent on any single trade.”  So, in the one example I could find where I would alter a trading comment that I had made in the original book, it was a matter of making the point even stronger, not disagreeing with the original concept.

 

The key and reassuring conclusion I walked away with after listening to my own book so many years later is that, while markets may change (e.g., the transition of futures trading from open outcry in the pits to electronic exchanges), sound trading principles don’t.

 

And now for a shameless plug: The narrator DJ Holte (http://djholte.com) did an incredible job. There is a 5-minute sample (preface and beginning of first chapter) on the Audible site:

 

 http://www.audible.com/search/ref=a_hp_tseft?advsearchKeywords=the+new+market+wizards&filterby=field-keywords&x=-1395&y=-49

 

The New Market Wizard Book Link

 

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Revisiting The New Market Wizards A Quarter Century Later