Lessons From The Multi-Pivots For June 20, 2011

[Billy]

I did note that Person did not talk of confluence. However, I was unaware until you wrote the below just how much of your system was original to you. Did the senior MM's follow quarterly, semester and annual pivots? Or, is that yours as well?

Yes Bob, that's how it worked back then. The bosses are focusing on quarterly, semester and yearly pivot timeframes, distributing and spreading over time the buying and selling of the houses's long term positions down the hierarchy.
The junior guy doesn't care about any timeframe above daily, he simply receives his volume to buy or sell for the house each day and he tries to optimize the VWAP according to the liquidiy and daily pivots. New institutional intraday orders keep coming in, but they normally don't change much the house's plan of action for its own account.
I guess today this whole process is fully automated in algorithms including all timeframes levels for optimization.
The only thing original from me was simply to follow the logic of weights and cluster strengths within ATR ranges, while everybody else is focusing on individual timeframes. I am trying to trade the collectively most probable setups, not the individual ones.
Billy

[adam ali]

Billy,

Is it the case - now that market-making has now effectively been taking off the "floor" and dispersed widely - it's difficult to truly know how MM is done today? I realize that if your pivot system works, it effectively means you DO know how MMs work, but it's interesting (at least to me) that's it's a guess and not a for sure. Or is something else coming into play that makes confirming how MM works difficult?

[Billy]

Billy,

Is it the case - now that market-making has now effectively been taking off the "floor" and dispersed widely - it's difficult to truly know how MM is done today? I realize that if your pivot system works, it effectively means you DO know how MMs work, but it's interesting (at least to me) that's it's a guess and not a for sure. Or is something else coming into play that makes confirming how MM works difficult?

Adam,

MM is done today with HFT and algorithms programs. It is turning more and more probabilistic and quantitative in nature. The very stable probabilistic results of the pivots methodology comfort me in my "best guess" that they are still at the chore of the market makers' programs. The best proof or confirmation of the guess is the backtesting done by Pascal which gave a zero % long term return from the pivot methodology when used independently of any market direction bias. In other words, when blindly selling and buying (reversing) at each 3:1 reward-risk long or short setups, on average in the long term, you will not lose nor gain anything (except costs and commissions).
Once you introduce a performing probabilistic market direction model like the 20 DMF, the same 3:1 reward-risk setups entries at the model signals suddenly provide exceptional returns and reduces the risk once you start holding the position for the number of days until the next signal change or stop hit.
Billy

Billy

[adam ali]

Ok. I'm reading you to say that the fact that pivot methodology neither makes or loses money in the back tests is what is to be expected, i.e., market making is not supposed to a "profitable" enterprise (although it obviously is), it is there to facilitate the smooth functioning of markets, price discovery etc.

[Billy]

Ok. I'm reading you to say that the fact that pivot methodology neither makes or loses money in the back tests is what is to be expected, i.e., market making is not supposed to a "profitable" enterprise (although it obviously is), it is there to facilitate the smooth functioning of markets, price discovery etc.

Wrong! What you must correctly read is that the pivot methodology makes a lot of money only if you are trading in the same direction as the majority of large players, including market makers. Market makers are making a lot of profits because they are the ones who are leading the large players directional moves.
Until 2007 it was relatively easy with classic volume analysis at cluster breakouts. Today only the 20 DMF can help
you when trading broad-based indices with the pivot methodology.
With the pivot system, you are in the same risk management setup as the MMs.
Billy

[adam ali]

Fair enough. Would it also be fair to say that we're "seeing" market direction after the fact (analyzing executed volume) whereas HFT MM, thru their algos, try to divine market direction by "testing" for market demand and supply in real-time?

In years past, the guys down on the floor had the book, could see demand and supply, and act accordingly. That sort of look is no longer available - at least not nearly to the same degree - as institutions got smarter about how their traders placed orders.

[Billy]

Fair enough. Would it also be fair to say that we're "seeing" market direction after the fact (analyzing executed volume) whereas HFT MM, thru their algos, try to divine market direction by "testing" for market demand and supply in real-time?

In years past, the guys down on the floor had the book, could see demand and supply, and act accordingly. That sort of look is no longer available - at least not nearly to the same degree - as institutions got smarter about how their traders placed orders.

MMs, and especially the largest ones, have the best big picture about institutional investor’s intentions. They seldom divine and only act on certainty.
Again, you can only really understand this if you've worked in a MM's trading room.
I could give zillions of examples for this, but one will suffice for now. Let's suppose a very large fund wants to start accumulating big positions in many ETFs and stocks. The fund will first call around all MMs houses to ask if they can arrange block trades at a limit price. Let's say $50 for 1,000,000 shares of stock A currently trading at $49.50. If the MM is holding the position in inventory at a lower VWAP he will probably be the counterparty if it fits well with its outsizing plan. If they don't have the stock in inventory, or worst are short the stock, the MMs will instantly call their institutional clients and other MM's to search for a counterparty. If the majority of replies is "No, thank you, could you also arrange to buy a block for me?", you can be sure that the MMs will rush to their buy buttons and will launch their buy programs like mad. And because all MMs have been contacted it quickly turns into snowballing to the upside because they want to accumulate inventories as low as possible before the big flows of orders start coming in.
Billy