If you’ve ever gotten a microphone too close to a speaker while they’re both plugged into the same amplifier, then you know the sound of a feedback loop gone crazy. If you could hear the sound of the stock market today, that’s what it would sound like.
The stock market is a very important part of our economy, theoretically. It’s where most corporations raise most of their capital. When it works right, the stock market is supposed to accurately determine the value of current and future assets of public corporations, and express them in terms of present value. If it doesn’t work right, corporations and their owners no longer have that measure of the value of their decisions and activities – they might be creating value, or they might be losing value, it’s hard to say. Not that the stock market (or equity markets in general) were ever a perfect measure — largely because future value is always uncertain and people don’t always behave rationally — but it was better than nothing.
In my considered opinion, today the stock market is worse than nothing as a measure of corporate value. It not only doesn’t provide an accurate measure, it provides a measure that is complete devoid of value but is still used to measure things. Kind of like a scale where the dial is hooked up to a slot machine.
The reason that I think this is what has happened in high-frequency trading over the last few years. These are completely computer driven trades, where buy and sell decisions are made in milliseconds based on algorithms, mainly driven by other trading activity – trading driving trading, a pure feedback loop. Each algorithm trying to game the other algorithms – I design software for a living, and I can tell you that ain’t good. The stocks bought are usually only held for a few seconds, and then sold. There is no assessment of corporate value, future earnings, or anything real, and a great deal of money is made based purely on gaming the system.
High-frequency trading accounts for something like 73% of all trading volume. Think about that. Any investor trying to evaluate real value is wasting their time. Any investor looking at charts is wasting their time. Any investor trying to maintain a balanced stock portfolio is wasting their time. The price will be set in milliseconds, with no connection to reality.
http://www.pbs.org/nbr/site/research/learnmore/inside_high_frequency_trading_100524/
http://www.nytimes.com/2009/07/24/business/24trading.html?_r=3&ref=business
http://market-ticker.denninger.net/archives/1259-High-Frequency-Trading-Is-A-Scam.html
