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April 16, 2012 – Comments (6) | RELATED TICKERS: UNG , COP

Some discussion on a few topics that have my interest. As usualy, I question convential wisdom (I am a skeptic by nature, what can I say)

Topic 1: Volume

 

People use volume as an indicator.  I sorta get it.  When a lot of volume is used in a certain direction, it probably means fund managers are behind the move.  These fund managers are longer term people, who will probably buy more of that stock as they receive more funds from investors.  So, I could see why that could make some sense as to why it confirms a move.  But there is still a part I really don;t get.  lets say a stock makes a move up over resistance, or just a big move up, on high volume.  The reason this is seen as good, what I usually hear said is "that shows there are a lot of buyers". WRONG. For every buyer, there is a seller.  This is the most simple concept.  You cannot buy something without somebody selling something.   So, if there is very high volume to the upside, not only does that mean that a lot of people were willing to pay up for the shares, but it also means that a lot of people were willing to get rid of their shares at that price because they don't think it will go up any more.  So, how is volume an indicator, if it really shows both sides of the transaction?  This boggles my mind.

 

Topic 2: Spinoffs "unlocking value"

To avoid getting into the specifics of a certain stock, I will make up an example.  Company XYZ has two sub business: coal, and textiles, and they each make up half of the companies earnings, $5 a share each. The coal segment is kinda slowing, and the prospects are bleak, and people hate it, and want to assign a p/e of 8.  The textile busienss is booming with good prospects and people love it, and want to value it with a p/e of 20.  8x5 = 40.  20 x 5 = 100.  100 + 40 = 140, making the share price $140/share, with a p/e or 14.  The company announces it is going to  spin off the two divisions into seperatre companies. WHY DOES THE SHARE PRICE START JUMPING UP BEFORE THE SPLIT?  People see this as 'unlocking value' because since the whole company trades at p/e of 14, now the textile business has a chance to trade at its fair value of p/e 20.  I completely understand why the textile business would shoot up AFTER the spin off.  But, the coal business should correspondingly DROP to a p/e of 8.  People start buying it before hand, because they want that textile business.  Why dont they just wait until the spin off and buy the company they like.  You are still buying the same crappy large business if you buy before the split.  Whatever value you gain in the good business you will lose in the bad one, hence why the share price was bad before the split announcement.

 

Topic 3: contango.

I understand how contango works mechanically in the sense that the contracts roll over into a higher price which depresses the price of the ETF (or whatever is used to track it).  NG is $4 this month, $5 next month, you lose a dollar on the roll over.  I understand backwardation too.  But, does this mean the best time to buy an etf that deals with futures is when you think the underlying commodity will do poorly?  "I am bearish on oil, so I am going to go long oil because it will continually roll over into lower priced contracts".  That is not how it works, I know, because I see the price go up for an ETF when the price of the underlying commodity goes up.  Tell me if I got it right: the share price for the ETF only jumps when there are short term spikes; The price of oil jumps really high for the current month becsuse there is a huge shortage, but people expect it to go back down over time, but they think it will keep going up until the roll over date?

 

Thanks in advance for the feedback!

 

 

6 Comments – Post Your Own

#1) On April 16, 2012 at 7:22 AM, Frankydontfailme (28.15) wrote:

for #1.

The volume on a breakout is easier to understand if you first look at a breakdown. If a stock collapses below a long term support on large volume, many shares were traded (usually from strong instiutional hands to weak-handed/tempramental speculators). As the stock continues down, every one that had bought from the institutions is now in the red. Speculators also often use leverage and so are spooked. If the stock rallies back to support (now resistance), they are desperate to sell. If instead it was a a drop with a few marginal shares traded, the composition of who owns the shares may be different (but collapses often occur on low volue whereas rise...)

For buying, similar but in reverse. Many new shareholders (usually the big money), bought on the breakout. They believe the stock will go much higher (duh, they're buying), and so if it dips a little, they buy more (hence resistance becomes support). If fewer shares were traded, the composition of who owns the shares is less clear. Are they strong hands? Weak hands? Leveraged? Who knows, but as you noted big volume generally means insitutions who use less leverage and aren't scared of a pullback. Furthermore, if resistence was a 52-week  high, then there is no previous resistance to overcome (could have manifested as supply from sour-grape traders who held for a while and want to get even)

On crazy volume, you sometimes get an 'exhaustion gap' because rather than the big funds buying big chunks, all the little guys were rushing in at once using leverage. Watch out below. 

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#2) On April 16, 2012 at 7:55 AM, danalexky (< 20) wrote:

My understanding is that there are not actually 2 parties (seller and buyer) in a stock transaction. There are three.  The seller, the market maker, and the buyer. The actual number of shares bought and sold do not correspond to people selling and buying. The market makers deliver more shares when buying outpaces selling, and drive the price up, and when selling outpaces buying, market makers lower the price and buy the stock. If we took a snapshot of shares outstanding at any given moment and counted them, they would almost certainly overshoot or undershoot the actual shares available. This is one reason my broker forces me to wait for settlement to free up money when I am 'all in'. 

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#3) On April 16, 2012 at 12:21 PM, dragonLZ (99.40) wrote:

I think #2 is right.

If there is always the same number of buyers and sellers (as you say, for every buyer there is a seller) then why would the price ever move up or down?

It is my understanding that when there is more buyers, the market maker (not sure this is the right term) is running out of shares and ups the price to attract sellers (which will provide new shares).

When there is more sellers, the market maker is buying shares that less and less people want, so he starts dropping the price to attract buyers and "slow down" sellers (you know how many people say: "I don't want to sell now when I'm already 50% under water").

If it really was like "for every buyer there is a seller", without the market maker, we would sometimes wait days for a transaction to happen.

I know this explanation is not very technical, but that's how I see it.

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#4) On April 16, 2012 at 1:33 PM, Valyooo (99.54) wrote:

#3: The price moves up and down because the sellers and buyers agree on a new price.  For every time the gas stations sells you gas for your car, you are a buyer. But the price goes up, because of the supply or demand.

So, you guys are probably right, and that is what my sneaking suspicion was.  But, still, for every buyer there is a seller...its just that sometimes, that guy is the market maker.

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#5) On April 16, 2012 at 2:23 PM, TSIF (99.96) wrote:

I like volume as a metric when used with other metrics.  As you noted, it's the quality of the buyer that can help a stock break through resistance.  While it' difficult to track, the NUMBER of BUYERS and the NUMBER of SELLERs is very unlikely to be anywhere near even.  Market makers aside.

I'm more inclined to use declining volume on a "trade".  A decline in volume usally means selling is exhausted and a base "might" be forming/firming.

On an upswing in share price, high volume can also be linked to short covering, which often fades rapidly.

Regarding unlocking value, I think that you have throught through it more than most buyers do else the share price would NOT jump too much in your scenerio.  Typically, however, it's not an "even" trade on how much one division is keeping the other down.  The theory is that both will trade higher because they will be able to "focus" or compete on their own merit.  The new company/ticker will initially get a spike due to index funds.  If the equity is low volume this could be substantial. Overall, the least desired half usually does sell off as those who "wanted" the other divest.  Debt allocation, focus, new ticker, ability to get the shares as part of a split and NOT have to buy on the open market.  Tax advantages from acquiring on the split, holding for long term gains, etc. add some variables.

Overall, however, I think you are correct. Patience would work better for most investors!

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#6) On April 16, 2012 at 4:35 PM, Melaschasm (56.75) wrote:

Topic 2: Spinoffs "unlocking value"

Some of the price run up may be emotional, but there are some possible explanations. 

If upper management is really bad at running one business, and really good at managing the other, a spinoff could result in a higher total value because the new spinoff management is likely to be less bad than the old.

While really big, diverse conglomerates have some advantages in the marketplace, they also have some disadvantages.  Bigger companies can more easily manipulate politicians into passing favorable laws, have a lower cost to borrow, or whatver else.  A smaller focused company is likely to be more nimble in the marketplace, and have various other advantages.  Depending upon the situation, the companies might be more profitable merged, or separate.

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