Relative Performance: The evolution of floor specialist to “virtual specialist”
24 August 2017
By Cory Todd
Back in the day, when I was trading on the floors of major exchanges and wanted to know what was driving a stock’s volume or performance, I would call the floor specialist directly. They would tell me if an institution was buying, what large orders were working, or even if they expected the trend to continue. But times have changed. That sense of transparency has been replaced with dark pools, high frequency trading, and iceberg orders. Fortunately, new advancements in technology are greatly improving our visibility into market structure, depth of book and institutional order flows.
After 20 years spent in the trading pits, I eventually found my way into the capital markets intelligence business at Q4, providing trading insights to IROs and C-suites of publicly traded companies. In this new role it became clear that we needed to find ways to gain even more clarity behind all the noise and fragmented order flow in today’s marketplace. This hunt for new methodologies eventually led us down the path to what we now refer to as, Relative Performance. Utilizing big data techniques we analyzed historical relationships between stocks, sectors and the broad market. Eventually, we were successful in engineering an algorithm to examine a stock’s volume and movement, and attribute each to specific categories or drivers.
Case Study: Foot Locker post-earnings trading
Foot Locker (Ticker: FL) announced their earnings on August 18th — missing expectations and catching the street off guard. At one point early in the trading session, FL shares were down close to 25 percent. Generally speaking, the majority of volume and movement following an earnings release will be specific to the company itself, rather than outside forces — and this clearly held true for FL’s performance (see screen shot below). Nearly 95 percent of the stock’s declines were driven solely by stock specific trading — while still contributors, peers, sector and the broad market weren’t the driving forces. FL’s losses were driven almost entirely by motivated institutional sellers looking to trim back exposure to FL — rather than HFT, index arbitrage, ETF flows, or other extraneous variables.
While the action in FL on the 18th might not seem all that interesting (the company missed and sellers moved in), it produced a ripple effect throughout the market. For instance, The Children’s Place (PLCE) stock, a retail stock which is highly correlated to FL was off fractionally, down just 0.45 percent. We see its peers — or in this case specifically FL — were dragging it lower by over 14 percent.
While PLCE’s overall price action would have appeared muted (-0.45 percent) to the casual observer at the time, there was actually a very interesting story happening behind the scenes. Peer flows (ETFs/Index trading and arbitrage) were punishing the stock, yet at the same time there was also a concerted effort by one (or more) institutional buyer(s), looking to take advantage of this flood of supply and accumulate PLCE shares. In other words, had there not been this stock specific buying, PLCE’s shares — influenced only by FL-related flows — would have been trading down substantially.
This type of analysis is not limited to a stock-to-stock only comparison either. Using the SPY (ETF tracking the S&P 500 Index) as a market barometer, we also see the broader market was down 0.28 percent during this FL post-earnings decline. Looking at the screen shots of FL and PLCE, we see both have the broad market negatively impacting their overall price performance — which clearly makes sense given the market was lower at the time.
How much each stock is impacted depends on how related (or tied) to the broad market they are. For example, a small cap biotech with one drug in the pipeline is likely to have a low relationship to the broader market, whereas a mega cap industrial would certainly tend to have a much higher level of connection. So while the former will typically not be all that impacted by the broader markets, the latter surely will. Regardless of where a company falls on this paradigm, we are able to attribute what activity is stemming from the broad market for a given security, and its impact on the stock’s overall performance.
The future of the “virtual specialist”
In many respects, “value creation” (or multiple expansion) is a zero sum game on Wall Street. Investors generally invest in one stock in lieu of another based upon their feelings about future prospects. Understanding why your company’s shares are moving the way they are, and who is driving it, is a critical component in stakeholder engagement and value creation.
The fragmentation of order flow, off-market trading venues and HFTs have unfortunately rendered the floor specialist all but obsolete. And for several years this had led to an undeniable loss in issuer clarity behind shareholder movements and real-time trading intelligence. But, thankfully, that is no longer the case. We now have the ability to attribute activity to specific sub-groups and participants within the marketplace. Dissecting volume and performance not only provides issuers with greater insights, but also with a better appreciation of the motives behind market fluctuations and company valuations. The physical presence of floor specialists is basically a thing of the past — something we’ll tell our grandchildren about. But, with the advent of technological breakthroughs, such as Q4’s Relative Performance, issuers are no longer relegated to the dark. Today’s “Virtual Specialist” illuminates the darkness and sheds light on market structure, trading drivers and institutional flows.
Cory Todd is the vice-president, quantitative analytics at Q4 and is a regular contributor of the Q4 blog.