Flash Trading Too Much of a Good Thing?
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After the fact, all my investing friends admitted that they knew something was wrong some time before, and, luckily, left the market. They never bothered to tell me, of course, so I stayed the course. I lost some money, but, luckily, I left it in and some time later I was back even. The trigger for the 1987 crash was interesting. Some years before, some smart analysts figured out a way to insure their stock market holdings. Buy these stocks and hold them - and buy these holdings so that, if your original holdings lose value, your back-up holdings won't. You can't lose.
You can't lose. Ah, savor the words. If only they'd kept their mouths shut, or, more likely, could have shielded their investment strategy from the scrutiny of other investors bent on mimicry. Too much of a good thing (the protection strategy) fostered too much of a bad thing (a market that couldn't react quickly to declines because too many folks followed the protection strategy) and we all know the result, those couple days of catastrophic loses.
Now, fast-forward to today. They say (Wilmott) that the newest trick is fostering a new disaster, as if we need another one to add to our woes. They say that increasing the speed of trades to take advantage of arbitrage opportunities (something is mispriced in a market, so take advantage of it even if the mis-pricing only lasts an instant) will eventually bring down the market.
Two facts from my point of view: the market is going to fall some time in the future. It might actually be caused by this new lightening speed trading. My prediction is actually two-fold: the market will fall, probably before the end of Obama's second term. Why it will fall, I have no idea. But it will fall. It's almost a given. But the other thing, the cause of the fall, is unknown at this time. It might be caused by lightening trading (I sort of like the name, don't you?), but my bet is that it'll be caused by something else that is unidentified at this time. I wish that all the things we have seen in the markets in the last one hundred years (mainly over-leverage, and too much reliance on analysis hiding risk-taking of unknown levels) was going to go away, that we had learned our lesson. Honestly, I don't think anything is going to change. My only prediction stands: there will be a fall in the market in the future. You might want to give some thought about how to protect your investments from that fall. Maybe your plan will actually work. I hope so.
One last thing: the administration wants to regulate lightening trading (they're calling it flash trading now - I like that name even better, don't you?). They're chasing solutions. Unfortunately, it's too late. Even if they regulate flash trades, traders will just move on to something else. Unless we change the underlying trading mentality, the deal-making mentality, nothing will change, really. Is that good? Well, I don't know. For a while there, a couple of months ago, I might have answered that the deal-making mentality had to go. Now, I'm not so sure. Capitalism is based on deal-making, isn't it? We'll have to see what happens.
Sorkin, Andrew Ross. S.E.C. to Seek Ban on Flash Orders, Schumer Say. New York Times. 4 August 2009. http://dealbook.blogs.nytimes.com/2009/08/04/sec-to-seek-flash-trading-ban-schumer-says/?pagemode=print
Wilmott, Paul. Hurrying Into the Next Panic? New York Times. 4 August 2009. http://www.nytimes.com/2009/07/29/opinion/29wilmott.html?pagewanted=print