How it all began

Facebook’s earnings conference call last night reminded us of that scene in ‘The Social Network‘ when Mark Zuckerberg and Eduardo Saverin argue over  introducing advertising to Facebook..

EDUARDO: It’s time to monetize the site.
MARK:
What does that mean?
EDUARDO:
It means it’s time for the website to generate revenue.
MARK:  I’m asking how do you want to do it?
EDUARDO: Advertising.
MARK: No.
EDUARDO: We’ve got 4000 members.
MARK: ‘Cause the Facebook is cool. If we start installing pop-ups for Mountain Dew it’s not gonna–
EDUARDO: Well I wasn’t thinking Mountain Dew but at some point–
MARK: We don’t even know what it is yet. We don’t know what it is, we don’t know what it can be, we don’t know what it will be. We know that it’s cool, that is a priceless asset I’m not giving it up.
EDUARDO: When will it be finished?
MARK: It won’t be finished, that’s the point. The way fashion’s never finished.
EDUARDO: What?
MARK: Fashion. Fashion is never finished.
EDUARDO: You’re talking about fashion? Really? You?
MARK: I’m talking about the idea of it and I’m saying it’s never finished.
EDUARDO: Okay, but they manage to make money selling pants…

Zuckerberg ultimately got his way, and things haven’t changed much since then.

The price of Facebook’s shares are directly related to the company’s speed and ability to turn their users into products for advertisers.

While Facebook’s ability to productize their users is not an issue (they have the means and the lack of ethics to do so), the company’s timing is what made the stock swoon during the conference call last night after market hours.

Investors apparently did not like what CEO Zuckerberg, COO Sandberg, and CFO Ebersman had to say about the company’s diminishing teen demographic and advertising challenges, but the major sell-off occurred at the start of the call and intensified as they spoke (see our notes below for our take on the after-hours price action).

This was our first time hearing Zuckerberg speak to investors, and the call left us amazed, confused, and frightened at the same time: Amazed at the CEO’s technocratic temperament (he’s no Richard Branson), confused about the glossy nature of some of the answers to direct questions by analysts on the call, and frightened for investors who have thrown over $100 Billion at the company.

Click image to enlarge

Conference call word cloud – the bigger the word the more it was used (click image to enlarge)

We heard excessive use of the words ‘believe’ and ‘think’ preceding many statements the three executives made about the company’s plans (see word cloud below) – words which lack conviction.

Words like ‘ads’ and ‘mobile’ and ‘growth’ made the company’s targets clear, but there was an air of uncertainty as they spoke about strategy. If you’ve never listened to a call it’s well worth your time, even if you’re not a FB investor: http://investor.fb.com/results.cfm

Why The Stock Swooned

Now, our Facebook Computer Algorithm has a heart as cold as Facebook Corp. itself, and our followers know that we don’t let our own personal feelings get in the way of the trading decisions it makes, but the words of these 3 chiefs were also absorbed by a mass of high frequency trading robots – computers which use sophisticated linguistic interpretation algorithms to parse the words of the call, analyze sentiment and sincerity in real-time, and calculate probabilities based on previous calls.  This is the latest in trading technology that is fueling the algorithmic trading arms race and is documented in academic papers.

This is why the stock was driven up immediately when Facebook’s text-only earnings document was released, but subsequently Face-planted during the phone call:  The computers just weren’t buying the story coming out of the mouths of those in charge.


 Update on the Stock Predictor algorithm:

Before the conference call, the Stock Predictor was short from $52.40 and up as high as 6% profit on the position. Shorting near earnings of an up-trending stock is considered a very risky undertaking (as we previously warned), however we had 2 other algorithms running for clients on different time frames and all of them were short from around the same price levels, so we kept the position open.

Earlier in the day we made our own human prediction in a tweet:

“If $FB gets a ramp today, earnings will disappoint. If it closes lower, earnings will impress.”

We based this on past manipulation we have seen after hours, but little did we know how prophetic our projection would become…

FB did close lower that day at $49, but when earnings numbers were released we saw one of the largest after-hours ramps we’ve seen in some time, with high frequency algorithms trading the stock all the way to $57. (our stops only operate during regular trading hours to avoid such folly, so the Stock Predictor maintained its position throughout the chaos).

To put the after-hours volatility into perspective:  from the $57 high to the $46.60 low equates to approx. $25 Billion in Facebook market capital, traded in a matter of minutes.

But the concept of market capitalization is really a fallacy since holders of a stock can never all exit at the same time without severely affecting prices, and this is especially true in the after-hours market.  As we tweeted this morning:

“Finding a fool to buy one’s house for a $million does not make everyone else on the block millionaires. such is After Hours Facebook trading”

Case in point: When FB reached $57, the arbitrage algorithms switched into vigilante mode and shorted at these levels: It then took exactly 87 minutes for the stock to swoon back to the RTH close at $49.

The Current Position

FB opened this morning after the earnings release at $47, but then erased the loss rising as high as $52 on the day.

As this retrace was starting, the Stock Predictor generated the current HOLD signal, exited the short trade at $50.75 (booking a +3.15% profit), and our list members were notified immediately.

The algorithm is now FLAT and not taking any long or short positions. This typically means that market conditions are not conducive to profitable trading, and the price action in the past 24 hours certainly confirms this. Orderly markets are usually the jobs of the exchanges and their respective market makers and specialists, but with Facebook it appears they are losing control.

Furthermore, global markets are experiencing high volatility this week and can sometimes lead to trend reversals. If massess of investors are liquidating their positions in equities, the USD currency pairs should confirm this.

Where things go from here could range from a healthy market correction, or a liquidity crisis, or a full blown market collapse, or somewhere in between… but we won’t make that call just yet. The algorithm could generate a new Buy signal, or a new Sell signal, or it could hold flat for the next while until market conditions change for the better, or for worse, but no matter what the outcome our Stock Predictor will identify the trend as it develops. .

Facebooked Into A Corner

As a result of the conference call, Facebook has officially been put on probation by investors to ensure that advertising revenue is on a continuous upward trajectory. For this to happen, Facebook needs time to convince their user base that advertising is _coo_l, but to do it they’ll need to boil them slowly over time like proverbial frogs.

Facebook will also need the full patience of investors to stick with them through this process. Investors are showing patience now (especially the smaller ones) but this could change as time goes on… after all, as Zuckerberg the character said, Facebook is like Fashion – it’s never finished.

So, to placate investors and analysts, we expect to see a lot of spin and damage control coming out of the CxO office in the next while to stabilize their stock price… because, as George Bernard Shaw once said: “If you can’t get rid of the skeleton in your closet, you’d best teach it to dance.”

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