Picture: ISTOCK
Picture: ISTOCK


It is no fun to have to sell a lot of securities quickly. If, for instance, you are a hedge fund whose clients have demanded their money back, and you need to sell all your stocks and bonds to get it, you will have a hard time selling them for what they are worth. (Or at least, for what they were trading for the day before you started selling.)

If you have a lot of stock to sell you will probably do it in chunks, and each time you sell you will drive the price down, so you’ll end up getting a much worse price on the last chunks than you did at the beginning. You’ll sell your first 1,000 shares at $50, and your second 1,000 shares at $49.50, and your 10th 1,000 shares at, maybe, $45.

But even worse, other people might figure this out and get ahead of you: if you sell your first 1,000 shares at $50 and everyone figures out that you actually have 10,000 shares to sell, then no one will want to buy from you at $49.50 or $49. They know that you are dumping a lot of stock and that the price is going to fall further. So they’ll back away, and only buy from you at $45.

Or they will even short the stock you are trying to sell, since they know your selling will bring it down, and then they’ll cover their shorts when you are done selling. But how do they know? How do predatory traders see you trade 1,000 shares and figure out that you have more shares coming so they should get ahead of you?

There are various ways — they can read about it in the press, they can have a magic front-running, high-frequency-trading algorithm — but here is one simple answer: your broker tells them.

Here is, Brokers and Order Flow Leakage: Evidence from Fire Sales, by Andrea Barbon, Marco Di Maggio, Francesco Franzoni and Augustin Landier:

"Using trade-level data, we study whether brokers play a role in spreading order flow information. We focus on large portfolio liquidations, which result in temporary drops in stock prices, and identify the brokers that intermediate these trades. We show that these brokers’ best clients tend to predate on the liquidating funds: at the beginning of the fire sale, they sell their holdings in the liquidated stocks, to then cover their positions once asset prices start recovering.

"The predatory trades generate at least 50 basis points over 10 days and cause the liquidation costs for the distressed fund to almost double. These results suggest a role of brokers in fostering predatory behaviour and raise a red flag for regulators. Moreover, our findings highlight the trade-off between slow execution and potential information leakage in the decision of optimal trading speed."

This seems like rather unpleasant behaviour from the brokers, but actually there is a plausible justification for it. If you need to sell a lot of stock, your broker needs to find someone to buy it. One way to do this is for the broker to call up their favourite clients and say, "Hey I have a guy who is selling a lot of stock, do you want to buy some?" It would be a bit dishonest of them to say, "Hey I have a guy who is selling a very little bit of stock, do you want to buy it": then their favourite client might buy 1,000 shares at $50 only to see the price crater as the liquidating fund keeps selling.

How do predatory traders see you trade 1,000 shares and figure out that you have more shares coming so they should get ahead of you? There are various ways...

Plus, of course, if it turns out that their favourite client wants to buy a lot of stock, then the whole trade can be done very efficiently and both sides can be made happy. The broker’s whole job is to match buyers and sellers; when they have a big seller, their role is to go call other clients and try to find buyers.

But the trade-off is that those calls leak information.

Brokers may decide to spread the news that a client’s large trade is likely to extend over several days to other traders. They may have an incentive to do so to establish a reputation as a source of valuable information and attract new business. On the other hand, brokers may care about the long-term relationship with their clients. Hence, brokers may be reluctant to foster predatory trading against a client.

Rather, according to this argument, they should invite other traders to provide liquidity and take the other side of the slow trade. It remains, therefore, an open empirical question whether brokers foster predatory trading or liquidity provision in case of slow trading by a client. The paper aims to address this question.

The answer is not great for the brokers: "The best clients of the aware brokers are significantly more likely than other clients to sell the stocks that the liquidating manager is off-loading during the fire sale with respect to immediately before the fire sale."

(We have talked a few times before about similar papers, one with authors who overlap with this one’s, about brokers who seem to leak valuable information about trades to their favourite clients.)

If a broker calls up their best clients and says, "I have a guy who is selling," and they all buy, then she is doing her job. If they call up their best clients and says, "I have a guy who is selling," and they all sell, they are doing something other than their job.

I mean, you can understand why! Their best clients are their best clients; they wants to make them happy. The fire-selling client, on the other hand, is … probably not their best client? How much more business are they going to get from a liquidating hedge fund?

If 20% of your net worth is in bitcoin you are probably overweight, but if 0% is in bitcoin you might be a little underweight

Bitcoin, always bitcoin

"The days of bitcoin stunt journalism are over," writes Felix Salmon. "Today, if you write about bitcoin, you can’t ethically own it, any more than you can own shares directly in companies you write about."

This seems to be a consensus among journalists, but I wonder about it a little. If you don’t have any bitcoins, doesn’t that make you biased against it? After all, I do own stock in most of the public companies I write about, not "directly", but in the sense that they are in broad-market indices and most of my money is in broad-market index funds.

My exposure to the companies I write about is not zero, it is instead a neutral amount: I own them in approximate proportion to their importance in the equity markets, and to my exposure to the equity markets.

It is hard to know what the "neutral" allocation to an asset is, but it seems reasonably clear that for prominent mainstream financial assets — Apple stock, say — it is not zero. If you had an otherwise normal, healthy market-cap-weighted allocation to a diversified portfolio of US equities, but zero exposure to Apple stock, then that would look a lot like a bet against Apple. You would be "underweight Apple" — almost like being short Apple — and your portfolio would do better, relatively speaking, if Apple went down than if it went up.

If Apple went up a lot, you would be sad, because you made what is in effect a conscious decision to bet against Apple by having less than the neutral amount of it in your portfolio. If you were a journalist writing about Apple, that might, to some fastidious observers, create the impression that you were biased against Apple.

On the other hand, no one expects you to be long Beanie Babies or dogecoin or Arkansas commercial real estate or penny stocks or whatever other niche investments some people are into, not even in proportion to their economic importance. It’s normal to have a normal amount of normal assets; it’s fine to have zero of niche assets.

In the glory days of bitcoin stunt journalism — when Kashmir Hill "lived on bitcoin in 2013" and bought a sushi dinner for 10 bitcoins (now $166,400) — it was an extremely niche asset. Now … I mean … I don’t know? It is still a little weird to own bitcoin, but if current trends continue — a big if! — then in a couple of years it will be a little weird not to. (At least in exchange-traded fund form or whatever.) In round numbers, the total value of bitcoin represents about a 10th of 1% of the total wealth in the world. If 20% of your net worth is in bitcoin you are probably overweight, but if 0% is in bitcoin you might be a little underweight.

Disclosure: I don’t own any bitcoin. And I feel a little guilty about it.

Meanwhile in bitcoin futures, Interactive Brokers "will now accept orders for short sales of Cboe Futures Exchange (CFE) bitcoin futures." You’ll have to post margin of $40,000 per (one-bitcoin) contract — over 200% — to short the futures at Interactive Brokers. (A long futures bet requires $9,000 of margin, and that 200% margin is a concession: at one point Interactive Brokers chairperson Thomas Peterffy said the margin to go short would be "in the neighbourhood of $100,000".)

The arbitrage spread between spot bitcoin and bitcoin futures does seem to be compressing a bit — as of early this morning it was about $485, or about 3%, down from $1,000+ when the futures first started trading — so perhaps easier shorting is leading to more efficient trading.

On the other hand, one Twitter thread from a guy who tried to sell some bitcoin said he found the process "so terrible, it’s almost hilarious". Enough exchanges have withdrawal limits, delays, complicated verification processes, etc, that converting bitcoins into dollars is not as easy as it sounds. If you are doing the spot/futures arbitrage, which requires converting bitcoins into dollars at maturity to close out the arbitrage, then I hope you have a better way of doing that conversion.

Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the US Court of Appeals for the Third Circuit.

• This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and/or its owners.


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