Siren Song Of The Imbalance

Some interesting action going into the month-end/quarter-end close.  We had a sell imbalance of $1.4 billion amongst large cap NYSE-listed stocks which I posted to Twitter.

I immediately posted a followup with a warning:

Overall, the aggregate imbalance numbers are useful.  From a birds-eye view they can give you important clues as to what’s going on in the market.  Problems arise when traders see huge imbalance numbers in individual stocks and think they can play them for easy money.  I’ve seen many traders get sucked in and whipsawed badly.  Hell, it’s happened many times to me too.  When you see a stock that trades a million shares a day post an imbalance of five million shares to sell, it can be pretty enticing.  Most of the time these plays are not as easy as they appear.  Nothing ever is.  Nine times out or ten, the imbalance is just an advertisement to suck you in — a siren song designed to steer your trading ship into the rocks.

One way to get whipsawed and lose money is due to “undisclosed liquidity.”  Let’s say there’s five million shares to sell in the book.  A screen trader looks at this and thinks it’ll be tough supply for the buyers to soak up and therefore it’ll trade lower to find bids.  They short a bunch.  What they can’t see on their screen is that there are a couple brokers standing right next to the trading post at the NYSE watching and waiting.  The specialist knows they’re size buyers.  Probably for a bank, or whatever.  Or maybe they’re on the phone, talking to a client waiting for the order.  Or maybe they’re not happy with the quote so they’re routing their order through a dark pool.  Whatever.  The point is, the screen trader can’t see them from the office.  Doesn’t matter anyways, because the screen trader is so blinded by the dollar signs dancing in their head that they’d take the trade regardless.  They’re just thinking, “This thing is gonna crater!”

Not only does it not crater — it starts printing upticks.  The trader at home is thinking OMG this is awesome, better prices —  put more on.  The stock keeps printing upticks and the imbalance hasn’t budged.  So they short MORE.  Next thing you know, the imbalance flips as the broker’s orders show up in the book to offset.  Now the screen trader is stuck short with way too many shares and forced to cover into the close.

I remember when I first started trading, the imbalances caused me nothing but trouble.  I saw all sorts of other traders making money at them and I wondered what they were doing different.  The best way to play them is to wait for a tell or be sure you have another edge in the trade.  Never just jump in right off the bat.  Wait for the turn card.  If the imbalance is huge and there really are no buyers, it should respond by auctioning lower, and will likely trade much lower from there.  If there’s a huge sell imbalance and the stock prints upticks, something is fishy.  It’s all about how the stock behaves under the circumstance.  Once you learn the psychology of your competitors, imbalances become fairly predictable.  Unfortunately, you need to watch hundreds or thousands of them in real time to develop a good feel.  Nowadays it’s a useless skill to develop because the good imbalance opportunities are few and far between.

I’m gonna post a chart of one of the imbalance plays I was in today in a weekend post.  Hint: it was EW.

Click here to learn more about NYSE imbalances.

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