Last-hour U.S. market madness seen abating for now

In the past month, traders could have shown up on Wall Street at 3 p.m. and not have missed much. The last hour, even the last minutes, of trading seemed to be the only ones that mattered in October. But the days of one-hour markets may be waning, at least for now.

NEW YORK (Reuters) - In the past month, traders could have shown up on Wall Street at 3 p.m. and not have missed much.

The last hour, even the last minutes, of trading seemed to be the only ones that mattered in October. But the days of one-hour markets may be waning, at least for now.

Traders say the intensity of these extreme late-day swings -- 443 points on average in the "witching hour" for the Dow Jones industrial average .DJI in October -- could let up as some of the so-called forced selling abates.

"I don't think the late-day volatility will be as evident this month," said Dave Rovelli, managing director of U.S. equity trading at Canaccord Adams in New York.

A sizeable portion of the last-minute sales came as mutual funds and hedge funds rushed to raise cash in order to pay back investors who wanted their money, analysts said, or in anticipation of such redemptions. Mutual fund redemption orders have to be placed by the last hour in order to be cashed out at market closing prices, boosting late-day volatility.

"The fiscal year for the mutual funds ended last week, so that selling should slow down a little. And most hedge funds should know what they have to sell out of for the year by November 15," Rovelli said.

Peter Kenny, managing director at Knight Equity Markets in Jersey City, noted that hedge funds "that were heavily levered in the commodities space have already liquidated a significant portion of their holdings."

In fact, volatility on Monday, the first trading session of November, was the most muted since before the Lehman Brothers' bankruptcy on September 15. But this was likely as traders were unwilling to place big bets before Tuesday's U.S. presidential election.

INSIDE THE ELECTRONIC CASINO

The last-minute swings in October were also exacerbated by program trading, said Ted Weisberg, floor trader with Seaport Securities in New York.

"Trading stocks has turned into a giant casino. The volatility has resulted in much more risk than most mortals are willing to assume," Weisberg said.

"One of the theories is that because of all the intraday volatility, people who use algorithmic trading, their algos hadn't caught up, so it all got compressed into the last minutes of the day," he added.

But the program trades also worked the other way -- pushing stocks higher on days when the market held up.

"You didn't know until the last five minutes how the market was going to finish. In the old days, the specialists used to have more command over the flow and would know where the buyers and sellers are," said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.

"Now, the market-on-close orders come in electronically and when you don't have liquidity -- that will whip the price around until the programs find a match," Saluzzi said.

Market-on-close orders are orders to be executed during the closing period of the market at the best price available.

Analysts also noted that for most of October, one of the worst months in history for stocks, risk-averse investors were reluctant to keep their positions open overnight, in case of unwelcome surprises in global markets.

WHIPLASH FROM THE YEN

Another spur for late-day selling was the sudden strengthening of the Japanese yen, which put a wrench in a favorite hedge fund strategy, said Marc Pado, U.S. market strategist at Cantor Fitzgerald & Co., in San Francisco.

The yen's steep rally last month forced an unwinding of the so-called "carry trade" -- a phenomenon of Japan's low interest rates, in which investors borrowed yen to finance investments in higher-yielding assets, such as U.S. stocks. In order to pay back their borrowed yen, investors dumped their most liquid holdings.

"The volatility fueled by the yen carry trade could continue, but I think we are in a phase now that we could see some weakness in currencies," said Knight Equity Markets' Kenny.

Saluzzi at Themis Trading hopes those who predict the end of the extreme last-minute volatility are proved right.

Caution may be warranted ahead of November's end, when the biggest trading houses, Goldman Sachs Group (GS.N) and Morgan Stanley (MS.N), close out their fiscal year.

Year end is another time when investors make dramatic changes in their portfolios.

"It remains to be seen how this plays out," Saluzzi said. "Hopefully we won't see that volatility again. That was some of the craziest stuff I've ever seen. Twenty to thirty S&P points within minutes -- that's not a normal trading pattern."

(Reporting by Kristina Cooke; Editing by Jan Paschal)