Fast Decline Is Momentum Buying’s Flip Side

Any time highflying stocks slide almost 10% in just three days, it’s natural to wonder whether sellers are flooding out of the woodwork to dump shares.

But amid the Nasdaq composite index’s fast 9.2% decline this week, investors should instead be asking where all the buyers went.

Indeed, traders say this week’s sell-off is due not so much to a herd of investors panicking out of stocks as to a sudden lack of buyers. That has forced sellers to mark down prices drastically to lure buyers, and it could portend serious “liquidity” problems in a more pronounced downturn.

Call it the flip side of “momentum” investing.

As technology and biotech stocks soared in recent weeks, investors were reluctant to sell, a dynamic that contributed to their huge gains. But now that momentum has swung the other way, buyers are hard to find.

“When you move down this way the buyers all freeze up,” said E.E. “Buzzy” Geduld, president and chief executive of Herzog Heine Geduld, a Wall Street trading firm.

That points up a trend on Wall Street. Whenever the market turns queasy these days, would-be buyers of volatile stocks are increasingly deciding to wait on the sidelines until prices stabilize, traders say.

To some extent, of course, investors always have been hesitant to buy stocks when the market has tumbled.

But buying demand seems to evaporate quicker than ever now, traders say. Momentum players such as day traders control the short-term action in volatile stocks, and even the biggest Wall Street firms are afraid to buy shares when momentum is going the opposite way.

“You don’t want to stand up in front of a freight train because you just can’t stop it,” said one trader.

Some experts say this week’s sudden dearth of buyers in Nasdaq tech shares could foreshadow an even deeper problem for investors in a prolonged downturn.

Liquidity--Wall Street parlance for the ease with which investors can buy and sell stock at reasonable prices--could be increasingly problematic.

“That’s one thing the public has to be aware of,” Geduld said. “If there’s a very real sell-off, liquidity just won’t be there.”

All of this makes it tough for individual investors to make trading decisions.

In recent years, small investors have been counseled to trade volatile stocks using “limit” orders, which specify the price at which they’ll buy or sell shares.

For years, most amateurs have used market orders, in which stocks are bought or sold at whatever the current price happens to be.

The problem with market orders is that some investors ended up buying stocks at exorbitant prices because that’s where they were trading by the time their orders were filled.

However, the volatility fueled by a lack of buyers creates new headaches for investors trying to determine the prices at which to set limit orders on gyrating stocks.

To illustrate, it’s important to understand that when Wall Street dealers want to buy a Nasdaq stock, they submit a “bid” price they’re willing to pay.

Imagine, for example, that the last price at which XYZ stock traded was $50, and that the current best bid price is $49.50. That means that at least one Wall Street firm is willing to buy the stock for $49.50, which is 50 cents below its last price.

In the past, traders say, several firms may have bid $49.50 at once, and each may have been willing to buy 1,000 shares. Today, by contrast, there may be only one bid at $49.50, and for only 100 shares. The next highest bid may be 100 shares at $49, and the next bid for 100 shares at $48.75.

In part because of sweeping changes that have reduced dealers’ power in the Nasdaq market in recent years, many aren’t eager to bid aggressively. If few other investors are stepping up to buy a stock, the price is likely to drop quickly once the first dealer bid is filled.

To help their customers, many online brokers list the highest bid price at any moment. Theoretically, an investor looking to sell considers that price when submitting a limit order.

The problem, however, is that the highest bid price may be misleading because it may cover only 100 shares and may be so much higher than the next bid price.

An investor submitting a limit order to sell at the bid price would be instructing his broker to sell his stock at no less than $49.50.

But by the time that order is handled, that bid price is likely to be gone. The investor order would not be executed because the market price is now below the price specified in the limit order.

Given this risk in a volatile market, investors must ask themselves how badly they want to sell a stock. If unloading it is a top priority, they may want to specify a lower limit price to increase the odds that the order will be filled.

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