Monday, May 17, 2010

Rumination on a Subject About Which I Know Little

The subject would be stock market.

I noticed the other day that the Dow, NASDAQ and S & P go up and down in almost perfect lockstep. If the Dow is up 150 points, about a percent, the other two exchanges almost always go up the number of points that make up about one percent of their total value. What does that say about how the markets function?

Everyone noticed a couple of weeks ago when the Dow plunged a thousand points before recovering some of the loss by the closing bell. From what little I’ve read, the cause was “computer panic” due to a big trade made by a broker. Seems to me that this is a big example of an everyday problem.

From, of course, Wikipedia:

“The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. The liquidity that an exchange provides affords investors the ability to quickly and easily sell securities. This is an attractive feature of investing in stocks, compared to other less liquid investments such as real estate.”

In practice, capital formation seems to be only a very small part of what the Markets do. The biggest part seems to be providing a platform for gambling among the big boys. The game they play, from my uneducated viewpoint, has little to do with the viability of the companies whose stock is used for chips. Indeed, the players seem to operate more in the roll of bookies, hedging their bets with side bets against the positions they are counseling their clients to take. Individual investors most in need of stability, are pawns in the game.

Here’s where I get dangerous. Maybe we need to get rid of the side bets. Should brokers be barred from trading for their own account? Get rid of options which seem to create volatility, not capital? Outlaw hedge funds – make your best judgment and be stuck with it, or sell what you bought at the then current price.

In short, strip the markets of the ability to any more than provide a means to offer, buy and sell company stock. Open season for MBA’s, have at me.


The Curmudgeon said...

Dave, I can match -- and I daresay easily exceed -- your ignorance on this subject. That confession made, I don't think farmers could survive without hedge markets. I thought I read that somewhere. These are futures and commodity trades.

But this is a heavily regulated field -- brokers are different from advisers. I used to know a whole bunch of names along these lines. Introducing broker. Guaranteed introducing broker. Certified Trade Adviser. I didn't much understand them then; I have managed to forget more than I ever learned.

My understanding is that the brokers make money on every trade -- and the smart ones would never risk their own money. That said, though, is it so bad that a broker trades for his own account? The unseemly part is where an adviser takes a position adverse to the one he is touting on his clients.

But MY gripe with stock trading is that price is unrelated to value and short term swings are triggered by failing to meet targets set each quarter by 'the Street' -- that is, by people who are outside the company and shouldn't know the company's business better than it does. Maybe if we taxed the proceeds of stock sales at a significantly higher rate than dividends we could reduce volatility in the stock markets?

Dave said...

Curmudgeon, I'll defer to you as I really, really don't understand the markets. I just know that they don't always, and more often lately usually, don't work. And yes there is a place for futures trading, as there's a place for arbitrage to stabilize commodity prices as arbitrage can do for money. But, the Chicago futures market used to do that quite nicely before the advent of "hedge funds" that seem to me to be pools of gambling money.