"The Strategy": a theory of market manipulation by big funds (Knuteson, 2018)

D

d0rian

I just found this article ("How to Increase Global Wealth Inequality for Fun and Profit"), which seems like it was much-discussed when it was published a year ago. Author points to the stark difference between intraday vs non-market-hour returns for all the major indices (noting that, astonishingly, nearly ALL(!) market gains, in the aggregate, are from overnight movement.) His theory seems to be that the only explanation for that anomaly is a handful of huge funds ($1B+) buying huge positions in the morning, and selling them in the afternoon:

"The Strategy is very simple: construct a large, suitably leveraged, market-neutral equity portfolio and then systematically expand it in the morning and contract it in the afternoon, day after day. The Strategy works because your trading will, on average, move prices in a direction that nets you mark-to-market gains."​

There's something fundamental I need explained to me, though: if the well-documented effect of overnight returns being massively larger than intraday...I'm confused about what the author's saying about funds profiting massively by...buying at open and selling at close (and repeating that each day). Wouldn't that...seem to be precisely the opposite of what the day-vs-overnight return patterns suggest is profitable(??) I'm missing something fundamental, I'm just not sure what...just what is the manipulative behavior that Knuteson is suggesting is driving the day/overnight split?
 
Speculating ... Could it be:
  • The "easy work" in the market is to make it move
  • The "hard work" is to make the movement stick, to cement the move, at least temporarily, at key levels of support and resistance

Concentrated North American smart money, appropriately, does the "hard work" for North American securities during regular North American daytime hours.

That hard work feeds on day-trading retail, which is always eager to trade for a move, rather than fade tests at support/resistance.

Maybe the operation of smart money is not so North-American trading-hours centric, but like I said, "speculating" -- would be interested to see comments from people w/ expertise in this area.
 
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Yea, have not read the paper but seems you would buy right before close and sell immediately upon open. And he says "market neutral" position... to take advantage of directional equity moves after hours? Makes no sense to me...
 
ktm said:
You are not the only one missing it. I think Knuteson was missing it too.
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science_trader said:
This paper is a joke. Nowadays anyone can publish whatever personal schizophrenia on SSRN and sound serious "because it is a paper published on SSRN".
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FYI: before jumping to the "he's just a clueless dummy with an internet connection" argument, know that he's a former MIT physics professor and hardcore quant trader with DE Shaw. This doesn't mean he's right -- just that he's got actual chops and shouldn't be instinctively dismissed as a quack. For those who haven't read the paper in the OP, I'd suggest you do so (it's short: ~4 pages), since I'm probably doing him a gross disservice in my description of his theory.

I found this 2nd paper of his published just a few weeks ago that follows up on that 2018 publication and adds some clarity for me:
"Each of your daily round trips, considered in isolation, is a money-losing effort. Properly and repeatedly done, however, your daily round trips push prices in your favor, causing mark-to-market gains on your large existing portfolio. The Strategy’s pattern of round-trip trading – expanding your existing portfolio when your trading moves prices more, contracting it when your trading moves prices less, losing money on your round-trip trading, and posting mark-to-market gains on your large existing portfolio due to the price impact of your trades – is market manipulation under any reasonable definition."
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So perhaps what he's suggesting (and what I was missing) is that you have an existing huge portfolio (say $10B of SPY), which you leave untouched...and then use a smaller chunk ($1B?) to execute these daily round-trips; you lose money on the $1B round-trip chunk (due to the documented intraday market ROI) but your activity has the effect of pushing up the market value of your existing $10B portfolio such that it's +EV in the aggregate(?)

Is that what others are getting from it too? To be clear, I'm not looking for a profitable strategy I can replicate myself (paper makes clear that huge sums are needed for that)...just trying to understand the mechanics of just what Knuteson says is saying this manipulative strategy that's been employed by large funds over the last 30 years.
 
d0rian said:
FYI: before jumping to the "he's just a clueless dummy with an internet connection" argument, know that he's a former MIT physics professor and hardcore quant trader with DE Shaw. This doesn't mean he's right -- just that he's got actual chops and shouldn't be instinctively dismissed as a quack. For those who haven't read the paper in the OP, I'd suggest you do so (it's short: ~4 pages), since I'm probably doing him a gross disservice in my description of his theory.

I found this 2nd paper of his published just a few weeks ago that follows up on that 2018 publication and adds some clarity for me:
​
So perhaps what he's suggesting (and what I was missing) is that you have an existing huge portfolio (say $10B of SPY), which you leave untouched...and then use a smaller chunk ($1B?) to execute these daily round-trips; you lose money on the $1B round-trip chunk (due to the documented intraday market ROI) but your activity has the effect of pushing up the market value of your existing $10B portfolio such that it's +EV in the aggregate(?)

Is that what others are getting from it too? To be clear, I'm not looking for a profitable strategy I can replicate myself (paper makes clear that huge sums are needed for that)...just trying to understand the mechanics of just what Knuteson says is saying this manipulative strategy that's been employed by large funds over the last 30 years.
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Yes, this was my understanding before I read the paper. If I had 10 billion in SPY, I'd definitely be willing to lose 1 billion to have my overall portfolio marked to market at 12 billion.
 
The author is misinformed. I think he was trying to imply in his incoherent rant is some hedge funds are using the overnight market to pump up positions & sell into the open. This is perfectly legal.

Painting the tape is illegal, which is done on the less liquid OTC/penny stocks.

Cramer - how the game is played
 
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comagnum said:
The author is misinformed. I think he was trying to imply in his incoherent rant is some hedge funds are using the overnight market to pump up positions & sell into the open. This is perfectly legal.

Painting the tape is illegal, which is done on the less liquid OTC/penny stocks.

Cramer - how the game is played
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Classic video. Now add dozus big boys news pumps to the equation.
 
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