Guest Post: "Pirates, Arbitrage and The Silver Flash Crash", by Viking Analytics

Our friends and subscribers at Viking Analytics have written an interesting article regarding last week's sudden, 10% drop in the price of Comex Digital Silver.

Most everyone here at TFMR saw or heard about the "flash crash" in Comex Silver that occurred at 7:06 EDT last Thursday evening. With theories abounding as to how and why it happened, we thought we'd post this commentary for discussion.

TF

"Pirates, Arbitrage and The Silver Flash Crash"

by, Viking Analytics

One of the quotes that guides my investment and trading philosophy is attributed to Benjamin Graham:

In the short run, the market is a voting machine. In the long run, it is a weighing machine.

- Benjamin Graham

I usually think about this quote with the second sentence in mind.  “In the long run, the market is a weighing machine.”  As such, I look for occasions when commodities and stocks have diverged from fundamental or benchmark values.  After a 25-year career in energy and commodities, I look for ways to profit from those fundamental divergences.  But, that is a topic for another article.

In this article, I want to focus on the first sentence: “in the short run, the market is a voting machine.”  I believe that this sentence provides some insight into the recent "flash crashes" that we have seen in tech stocks, gold and most recently, silver.

Here is the one of the problems with the “voting machine” market in the short-run:  there are entities who have the ability to stuff the ballot box and profit from nano-second moves in the markets.  Perhaps especially during times of limited liquidity, the market "voting machine" can easily become an "arbitrage machine."

Silver Flash Crash

As has been widely reported, the COMEX silver market (owned and operated by CME Group) "flash crashed" from a high of $16.07 to a low of $14.34 before recovering to close at $15.90 over a 5 minute trading block of 8,000 contracts. These 8,000 contracts amount to 40 million notional ounces of silver, which is 4.4% of annual mine supply traded in 5 minutes!

Source: TradingView

Becoming a Pirate

One of my favorite quotes from film comes in one of the modern renditions of Peter Pan in the movie Hook. Peter Pan (played by Robin Williams) has left Never-land, and has become a swashbuckling investment banker. Wendy, now much older, goes to Peter Pan to let him know that he is needed in Never-land to once again battle the pirates.  Upon seeing Peter’s newfound enthusiasm for profiteering at the expense of others, Wendy is astonished.  She says, “why Peter, you’ve become a pirate!”

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While I have not become a pirate, I have found that it can be occasionally profitable to think like one. In a game theory analysis of the commodity markets, I try to think like a pirate would think.

If I Were A Pirate . . .

Before we get to our pirate flash crash strategy, let's look at a recent bid-offer stack for the iShares Silver Trust (SLV).  In this example, there are almost 400,000 bids to buy SLV at 14.91, and almost 110,000 offers to sell SLV at 14.92.  We can see bids and offers above and below these levels.  Most retail investors have the ability to see this bid-offer stack in the stock markets, and the same kind of bid-offer stack exists in the futures markets.

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Source: E-trade

If I were a pirate (I am not), having the means to do so (I don't), I would evaluate the bid-offer stack of my target commodity, and during times of illiquidity (like 4am EST on a Monday, or 7pm EST on a Thursday), I would set up limit purchase orders 5% to 10% below the current price (for example), and then place a sell order that hits every bid in the bid stack.  At key technical trading levels, I will have the added benefit of triggering known and unknown stop loss orders.

The cascading effect of the flash sale, combined with the known and unknown stop loss sale orders (designed to protect long positions and/or profit from a new downtrend) would ideally cause price to decline to the place that I had established my purchase orders.  In my perfect pirate world, the short orders that I had created to hit every bid would be covered by the purchase limit orders that I had created below.

This pirate activity can of course be optimized by HFT algorithmic computers that have a form of market price omniscience, being fed continuously with the bids and offers, and oftentimes the stop loss data as well.

Five minutes later, price recovers almost to where it was before, and I would have arbitraged the bid-offer stack, making millions from my market omniscience in an illiquid market.  I am not a lawyer, and I have no comment on the legality of this activity.  I can only assume that the activity is legal, but perhaps represents a serious market inefficiency.

Who Loses In This Flash Crash?

The losers from the flash crash are the retail and other investors who do not have the same level of information and market-moving ability as others, and who have attempted to protect their long positions with stop-loss orders.

I have copied a couple of tweets from this morning that elaborate on this point.  First of all, I must say that I am impressed that CME Group responded quickly to adjust and correct some of the orders made during the flash crash period.  Whether CME was “fair” in the allocation of fills is not for me to decide.

One trader reported that he had a long position in silver futures, and had established a protective stop loss order at $15.80/oz.  Unfortunately, stop loss orders are sometimes only triggered if there is an actual bid or offer at the exact level of the stop loss order.  In this case, the trader’s stop loss order was not filled at $15.80 because liquidity in the market had vanished when the bid-offer stack was raided.  When the market adjusted a nano-second later, the next quoted bid was used to fill his stop loss order with a sell at $15.00.  As a result, his protective stop loss order was originally $0.80/oz lower than what he had set.  An $0.80/oz loss on one futures contract in silver is worth $4,000.  

Fortunately for this investor, CME Group corrected adjusted his order to a stop loss at $15.56, so he only lost $0.24/oz more than he had anticipated with his original stop order.  But that $0.24 still amounts to $1,200 lost in a nano-second on a single futures contract.  

After the dust had settled five minutes later, if this trader had not had the protective stop order of $15.80, he would have retained his long contract at a value of $15.90. In this case, the retail investor was easily fleeced by a 5 minute down-up spike in the price of silver. 

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Applications

We have attempted to alert readers to this kind of activity before, but it is of course complex and takes some contemplation to follow along. This example above is a more detailed example of what I attempted to explain in one of my prior articles: Trading JNUG and NUGT? Play Blackjack Instead.

Because this kind of stop-running activity can occur in all markets, in my trading I try to focus on the end-of-day closing price and set mental stops, not actual stop loss orders.  This requires more screen time and discipline.  During times of high liquidity, stop loss orders might be good to have.  However, it is important for retail investors to know that some or most of their stop loss order data is sold to firms who have the ability to profit from that information.

Finally, thinking like a pirate helps me to understand where the pirates might be steering the pirate ship.  I ask myself, “if I had vast resources and more perfect information, how could I arbitrage the market tomorrow, next week or next month?”  I am currently studying the very deep and influential options markets in COMEX gold and NYMEX crude oil, and have developed tools to calculate where the “sweet spots” or “price magnets” are located.  If I were a pirate, I would seek to capitalize on the fear and greed that I can induce into these markets, and sell volatility at key support and resistance areas.  But, that’s just me.

I share this kind of research with my Seeking Alpha subscribers, as we seek to navigate the rocky shoals of these markets together, and hopefully avoid the pirate ships along the way.

50 Comments

Turd Ferguson's picture

Re Monday

MODERATOR

My schedule is such that there will not be a morning post on Monday. There will, however, be a full podcast summary and review recorded and posted at the usual time in the afternoon.

Thank you for your patience.

RickshawETF's picture

First!

Patience, Turd?

We've been waiting SIX YEARS for silver to hit new highs!

I think we can wait half a day for your Pearls of Wisdom . . .

canary's picture

The extreme COT ...either bearish or bullish

Is the strongest factor for me how to position myself for the next few months. Everything else is a secondary to me. I don't think there was any exception to that rule since the financial crisis.

Wish I followed this principle from the beginning of my PM involvement.

Still keeping my core position.

Markedtofuture's picture

First Majestic Silver—The Purest Silver Company in the World

Keith Neumeyer founded First Majestic Silver in 2002 and has grown the company into a premier billion-dollar major silver producer operating six producing silver mines in Mexico.

https://secure.campaigner.com/csb/Public/show/hj8j8--csner-5l3sb1a7

abundance's picture

Keith Neumeyer on davejanda today

Marcus's picture

Fat fingers

Interesting, isn't it, that a "fat finger" always involves the selling of the metals and never the buying. I'd like to see gold go limit up, for once, and have it ascribed to a "fat finger". Fat chance of that ever happening.

Hey, manipulators, have I got a finger for you. Two, as a matter of fact.

NW VIEW's picture

Pirates and Bigfoot!

 These are amazing times.  I finally saw my very first captured bigfoot yesterday.   I was watching the parade at the yearly Cheese Day event at Toledo, Wa.  (Great small city event and great old car show).  There it was, in a large cage, riding in the back of a truck and looked almost real.  

There are some major events coming and who really knows what is going to trigger the real events?   We have been given the warnings of the flying saucers, the hollow earth, space aliens, underground cities in the arctic, citizens living on Mars, CERN, portholes, the return of the giants, area 51, etc.  

That bigfoot is the closest thing that I have seen, so far, to anything on the huge dreamers list.  The things that I have seen, dealing with the demonic, are swept out the door and that is one event that will truly be seen in the future.    Few are actually prepared to deal with these haters of mankind.    A good 338 will take care of bigfoot and lizard men from the deep but is totally useless within the spirit world.     jmo     

lakedweller2's picture

Futures

Nondescript.  Waiting for us to turn our backs.

JQuest's picture

Jim Willie 7/9/2017

His voice is shot from being sick but he makes a good effort.

happycamper515's picture

PMs headed south again

This close to 1200 gold they're surely not going to pass up the chance to trigger those stops. Silver at 15.24 lower than Friday low. Ugly. USD/JPY going crazy again. Nobody fearing the Andy trade at the moment. 

cobber1212's picture

I Don't Trust Andy, Should I?

So Far.....  Big Hat no cattle. This guy might make a good lunch pitch but he hasn't been correct on any predictions, has he? Trust like respect is earned. Craig: I trust you but why does he go on the carney barkers (Eric King) site all the time. I believe he gets softball questions. One mans opinion.  The info noise in the PM's is deafening!

We need the truth to trickle out.

Respectfully,

Cobber

bookers126's picture

GSR

GSR is now 79, looking hopeless at this point.  Probably headed to that 85 because that is what it spiked to last week.

Angry Chef's picture

Exposed! Bussed-In Baltimore Protesters Promote Violent...

....Revolution In America

http://www.zerohedge.com/news/2017-07-09/exposed-bussed-baltimore-protesters-promote-violent-revolution-america

How come George Soros and anyone associated with his "foundations" is allowed to sponsor revolution and revolt all over the world ?

Angry Chef's picture

Dr. Dave and Robert David Steele Interview

Anybody that dissed Tyberious in the previous thread should listen to Dr. Janda's interview with Robert David Steele.....

http://www.davejanda.com/audio/RobertDavidSteele070917.mp3

silver10sguy's picture

COT More Bullish This Friday?

I really hoped this morning the price action would be better.  Ugh!   Well,  Andy said something was going to happen soon.  If not the COT might be even more bullish this Friday.  Hmm.....

Joseph Warren's picture

Attitude: When Not to Give a F*ck

Personally, I think the guy who used to post that 'it's all just a simulation' may be closer to the truth than I used to think. The pirates make DG and DS do all sorts of things. Many of us, after years of research, are convinced that has nothing to do with the real value of the physical metal. If you need to sell a little to pay some bills, that sucks. Till then, why let their shenanigans get to you. Especially, when you can do nothing about where they make the charts go. All we can really do is buy, sell, or hold.

Perhaps this will help -

https://markmanson.net/not-giving-a-fuck

P.S. - as for the success or failure of any of the many prognosticators in the PM space, - that's their problem, not mine. All I can do is buy, sell, or hold. Those decisions are based on many factors but the final action is mine alone. As are the consequences of my actions.

AlphaRob's picture

Selling AU to buy AG

Could be in for lower prices, hopefully this is the final shakeout before the breakout. I am considering selling a large quantity of AU and buying AG.

Ned Braden's picture

Dave Janda Interview #UNRIG

Anyone who has NOT listened to this interview (posted above) needs to stop and listen to this.

Right NOW !

http://www.davejanda.com/audio/RobertDavidSteele070917.mp3

Dr. P. Metals's picture

@Ned

interesting audio

Pining 4 the Fjords's picture

I've admittedly been on the wrong side

these last two weeks, should have listened to Argentus when he said I had it a couple of weeks early!  Nonetheless I am holding here and waiting, but I don't expect an instant turnaround.  If the big banks are covering like crazy as I think they are, they still have today and tomorrow before that info gets recorded for the cot week to be reported on Friday. So they'll want people to keep adding shorts, and maybe a raid or two to harvest remaining longs (gotta be lots of round- number stops to run at 1200 and 15, so a dip below one or both is probable). Then they still have wed-fri to pile on before the true extent of what they've done becomes public at 3:30.  We may see a rise during that time as they add longs, or may not.  But I've f I'm correct, then the table will finally be set and we'll eat.

Angry Chef's picture

BANK BAILOUT IN ITALY, AND A PROBLEM LOOMING IN....

...BETWEEN THE LINES

https://gizadeathstar.com/2017/07/bank-bailout-italy-problem-looming-lines/

Just a guess but the recent bailout of Banco Monti dei Paschi reeks to high heaven. Does anybody recall only some 6 months ago many pundits stated that a Banking crisis would likely begin in Italy ? We all know that Germany and France ( mostly Germany ) runs the Eurozone. So is this bail out of the Italian Banks a way to hide the collapsing Deutche Banks failing derivative book behind the scene ? We'll likely never know but the ongoing smackdown of the PM's coinciding with BMDP being bailed out may be related.Somebody had to sell some Gold & Silver contracts quickly to raise liquidity...perhaps. And the recent takedown of some high level Vatican officials seems odd. Especially when one of them was a high level Vatican Bankster. If somebody needed Gold in a hurry the Vatican Bank would be a source I speculate. And what better way to force there hand than with child pornography and pedophelia. And with all those Goldman Sachs Banksters in Trumps cabinet is maybe Goldman setting themselves up to take out the Vatican Bank ?

All speculation on my part but be patient folks. I think we're going to see things get really rough over the next few months.

Fatso's picture

@ angry Chef ...BETWEEN THE LINES

WOW!!! very powerful speculation.

Thank you very much

https://gizadeathstar.com/2017/07/bank-bailout-italy-problem-looming-lines/

JQuest's picture

@ BETWEEN THE LINES

This theft by the 1% via bail outs have made a lot of elites extremely wealthy....

How many of the non-performing loans were just criminal shell games that are being paid for by the 99% ?

We've been had ! frown

lakedweller2's picture

We Were Had @ Jquest

That's why Hank Paulson, Geithner, Bernanke, Summers, Rubin and many others should have been put in jail at tbe time of the first bailout.

TF Metals fan's picture

What is this new London Metals exchange?

https://www.bloomberg.com/news/articles/2017-07-09/gold-elites-challenged-by-base-metals-bourse-on-market-s-future

Is this connected with the ABX Andrew has been talking about? And the LME teaming up with Goldman and Morgan Stanley against the LBMA? It feels a bit like poachers turning gamekeepers. Or is this just very good news and I shouldn't be so skeptic?

Doople's picture

Tahoe Resources

Not sure if this has been posted.

SRS Rocco rips management for their ignoring and abuse of the local population.

https://srsroccoreport.com/worlds-2nd-largest-silver-mine-shut-down-implications-for-company-market/

JackPutter's picture

These metals smash-downs are often accompanied by

the restrictions and expenses associated with LIBOR.  The interbank lending sphincter squeeze causes assets and positions in portfolios to be liquidated.

joeblack's picture

Andy McGuire...

Has he ever warned us a large price decline was coming?

Andy talks his own book.

AGXIIK's picture

NW VIEW everything you mentioned was commentary from Clif High

What we need is real pirates.  

Pirates in full battle rattle, buckling the swashes, parrots in camo, pistols, swords and broadside.  Then shove us all into the voting booth. We vote for silver and gold.

If we can't find  gold in the booth we  sail down wall street to the banks and yo ho ho those cons of bitches until they fat finger the prices higher or walk the plank

It's a pirate's life for me.  

We sailed the Good Ship Venus. 

By gar you should have seen us  

The ship's mast head 

Was a----

Oops   Family site warning. Mustn't be rude. Ladies present

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