The objective of this second part will be to continue the line of reasoning initiated in the first part, exclusively dealing with the relationship between the future index (IND) and the Bovespa Index (IBOV) and how the players that win in the arbitrage between these two markets make me discredit of the use of technical analysis for stocks in the intraday tiume frame.
As we know, future index contracts are financial agreements where the object of trading is the Ibovespa index’s score at a predetermined future date. Thus, the quotation of the future index derives (or should be derived) from the IBOV price serie. However, as you know, the players in the future index markets and stocks are not the same:
- In the future index we will have players: seeking hedge of their stock portfolios, speculating, set up very short-term operations based on tape-reading, technical analysis or quantitative analysis and institutional investors seeking to allocate resources in the country quickly and cheaply. They are, therefore, responsible for most of the movements in this market.
- In stock, we will have the full range of investors already discussed in the first part. In this way, I highlight institutional investors seeking to set up medium and long-term operations based on fundamentalist analysis and passive management fund operators.
Are those uncorrelated and simultaneously buying and selling pressures that open the space for the Cash & Carry operations can be done.
Cash & Carry
Cash & Carry is an arbitrage strategy between spot and futures markets, where the trader buys / sells one of the assets and do the reverse operation on the other, seeking to exploit temporary inefficiency between these markets.
There is, therefore, a mathematical relationship based on economic precepts that governs the future index price (as well as any other asset traded in the futures market, being a commodity, currency, etc.). The future index, in this case, is a function of the IBOV price, the weighted rent rate of the assets that make up the theoretical portfolio of the index and the interest rate practiced in the economy, carried over to the contract’s maturity.
However, as we can see in the chart below, however much the two assets seem to go together, there are times when there are inefficiencies:
Notice, however, the roughness in the chart below. If the relationship between them is below average, it would be possible to make profits by buying the future index and selling the shares, waiting for the ratio to be corrected to dismantle the transaction (the opposite is true if the ratio is above normal).
As a zero-risk operation, there is a lot of competition in this market, and those investors with access to very low costs (generally, investors who participate in the BMF & Bovespa incentive program for high-frequency traders), as well as those with high execution speed (Investors operating via co-location) will have advantages over other players when capturing these distortions.
So it’s the future Index that follows IBOV?
No. Much as in essence, future index derives from Ibov, in practice what happens sometimes is the opposite. A foreign investor wishing to trade relevant resources in the Bovespa index will have two ways of doing this:
- Buy the theoretical IBOV portfolio (following the appropriate proportions), share per share. In order to do this, you will usually have to run one of several execution algorithms simultaneously (T-WAP, V-WAP, Pegged or market orders in the closing auction), running the risk of influencing the market price of such shares, paying (Average, large investors pay 0.1% of their operations’ financial transaction costs in stock transaction costs).
- Buy the future index in a simple, instant and paying only 5% of what they would pay to do the same operation in the stock market.
Thus, buying or selling the future index becomes much easier than trading stocks. It is no wonder that the futures market (IND and WIN) trades twice as much as every stocks together.
In this way, when we say that there is a foreign flow moving the stock market, we are talking about a buyer / seller flow entering (in most cases) the future index and being felt by the stocks by the arbitrators operations.
Obviously this is just one of the possible moves. If the futures market is low in liquidity, reverse trading can also happen.
And what did we conclude?
We conclude then that if these movements caused by other markets occur all the time, the basic concept of technical analysis (in the intraday spectrum) would lose its meaning. Price does not predict price! In other words, the idea that past prices would contain indications of future movements is not valid since most of the stock movement would result from movements of the future index brought to the stock market through the action of the arbitrageurs.
See some examples of intraday movements. Below is the graph of the future index (INDJ16) of 06/04/2016.
Now see how 6 of the most importants Brazilian’s stocks did traded that day (PETR4, VALE5, BBDC4, KROT3, LAME4, ABEV3).
Pretty simmilar, huh?
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