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Dreman: Yeah, they’re at 55-65% on average. In the August-September period, they might have been as much as 80%, 85% of trading. They do perform some functions as market makers, but also, if a stock is moving down sharply they’ll pile in.
They have what they call “stuffed bids,” which makes it appear, after they’ve taken a short position, that they could put a short in for four thousandths of a second and offer to short, say, $100 million. And by the time you move your hand to buy and you to execute the order, it’s gone. There’s a lot of that, and the profits were enormous for these people. They don’t hold stocks. They probably want to close out every night.
Forbes: Would you call them “vulture investors?”
Dreman: I would, but they certainly disagree with this. But I think they really are very dangerous for the average investor because they scare both professionals and amateurs out of the market. I mean, you’re just seeing these enormous mutual fund redemptions because of them.
I think that, also, they all seem to trade in packs. Now, that’s maybe pure chance. I don’t know. But when one sells, another will sell almost instantaneously. As you said, Steve, they accentuate the downturns. And similarly, if the Dow rises 100-150 points, they’ll be very, very long.
Forbes: Now, you suggest to investors in this kind of environment, “Don’t get out of the market.” But you first say don’t do stop-loss orders, that doesn’t work anymore.
Dreman: Yes.
Forbes: You also suggest exchange-traded funds as a way to protect yourself. Can you first discuss why we shouldn’t do the old traditional stop-loss orders?
Dreman: Well, stop-loss orders were always good. But the liquidity in one of these downturns where you have 85% of the trading going one way, we saw that with the May 6th, 2010 crash –
Forbes: The Flash Crash.
Dreman: The Flash Crash, yeah. Some stocks were down as much as 65%, 70% or more. And it wasn’t a few, it was dozens and dozens. The exchanges stopped that, they repaid those people, but a lot of stocks were down 50%. Really, there was just absolute panic, and liquidity totally dried up.
A stop-loss will, when you put it in, if we say your stock was 50 and you sell it at 49 and 7/8 or better, people won’t be hurt by it. So I think in this kind of highly volatile market, you probably want stop-loss orders on the one side, and you also want orders that limit the price stock can be bought on the other.
Forbes: So you still like stop-loss orders? Does it still work in this crazy environment?
Dreman: Well, it keeps you out of the craziness because the high frequency traders are not going to keep these positions, they’re not going to drive the market for more than that day. And even, I think, in that Flash Crash, slowing down a little bit, which they did do. Slowed the trading down, saw it peter out, then buying came in and market came back pretty sharply.
Why ETFs?
Forbes: And why ETFs?
Dreman: Well, I like exchange-traded funds because with this enormous volatility, they give you more diversification. If I were going to buy, say, exploration and development companies, one ETF will give us every exploration development company in the S&P, equally- or market-weighted. So we’re getting a good diversified portfolio, rather than having a portfolio that has a few stocks that just may have a chance negative advance.
Forbes: And what do you feel should be done? Because if you put a tax on these things, they’re just going to go offshore.
Dreman: Well, I think the tax would, since in more normal markets, they trade for a fraction of a penny. There’s one house that even has barrels of pennies at its headquarters to show that that’s what they make, but they do so much volume. But that would really take the profit margins out of this. The average investor wants low liquidity.
The VIX was 18 in July, the Volatility Index. And it got up, in August, to 44. It was enormous. I think this would limit this kind of trading, which is really not good for the average investor. It’s not good for the institutional investor.
Forbes: But would it stop the trading, or would they just do it from Bermuda?
Dreman: Well, that’s interesting. They’d still have to trade, I’m certainly not an expert on how that would work, but they would have to trade on an American exchange or a European exchange, and there’s probably a way of taxing each trade in any case.
Forbes: But the bottom line is for all of this, investors, if they just hunker down and either get in the market or stay in the market you think we’re in for another post-1982 kind of world, or at least semi-post-1982 world? Big gains coming?
Dreman: I think so. I think our companies have rarely been in as good shape, financially. And earnings are good. If they take a slight dip, stocks are still relatively cheap. Whatever tranquilizer one needs for the market, whether it’s valium or there’s something far advanced – your stomach might turn over a bit more. But I think that the market is the place to be. With the possibility of inflation four or five years out, I think the bond market, particularly the long-term part of the bond market, is about the last place I’d want to be.
Forbes: Well David, thank you. And the book is, again, Contrarian Investment Strategies: The Psychological Edge. Thank you.
Dreman: Thank you very much for having me, Steve.
Forbes: Thank you.
source: forbes.com
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