What controls the stock market?
The market is always in crisis. Recent events mean that it’s hard to catch a glimpse of a sunrise even if you want to. As usual, stocks rise and fall, lockdowns seem like a natural intervention to prevent self-destruction, yet additional money pouring into the world of stock markets isn’t exactly helping the crisis.”
What controls the stock market” is one of the more common questions we are asked about the market. Usually, the nature of the market and history are used to explain what controls the market. But were the answers provided in modern versions to the question really worth asking? The last time we checked markets were still functioning, so if the market needs controlling then how does it control itself? Global market operations are run through a system of computer networks, yet many questions have been raised about the security and integrity of the industry.
The main question concerns market investment strategies which is often confused with stock picking and individual stocks. Currently, the models based on market momentum tend to work to the advantage of those who know the market well. But the question of whether these companies can actually pick only the best stocks comes down to the rigor of the models. As Kahneman and Silberman (2011) highlight, there is no specific “technology” that leverages market information in the same way as “real life” expertise. Rather it’s more like single entry price mechanisms.
So, there may still be no reason to sell the last stock which pays a higher dividend and fewer taxes because the stock will be bought for less than its value, but the correct supply and demand equation may have already played out for others. The short-term strategies base on initial selling should be fully considered in advance and you will be blaming yourself when these are replicated for yourself and you end up selling your portfolio too soon.
With the recent experience of and fear of the dark derivatives, the few people involved with the whole process are trying to find a solution, but none have yet proposed a competitive point of entry, so they are all just playing around. Anyone worried about a dishonest “marketer” could just “vaccinate” themselves with alpha, which is a concept based on low volatility and low correlation.
Something everyone would want to have as they take on this job; after all, our seats ain’t cheap! The discussion on underlying standards is also not very far off the mark. Simon Lee (2008) discusses issues such as loop bams, but the change may be needed for a better deal. To start, the market should never decide which stocks should be, but should “wait” until they reach the benchmark level. If it currently considers only small purchases in stocks to be out of line, what could stop the market from setting higher limits on stocks it considers overvalued? In particular, critics are concerned that large firms are creating the wrong incentives and no longer acting in the best interest of the shareholder.
Maybe these firms are trying to “protect” themselves from losses. But why not test these markets and decide on their application? If that’s how these firms make money, perhaps the best action the market should take is to ban all these very profitable firms? If investors wonder why they don’t want to buy into or hold particular firms, it may be easier to stop blindly following them and protecting them, and support innovative firms instead.
Erez Navon (2010) has another perspective on the market: to take advantage of long-term trends. But no matter how optimistic the long-term market trends are, markets give themselves over to short-term crises like the one we are in at the moment. So, like everyone else he worries about the increasing “myth of a pre-determined set of forces”, how could it actually control itself? But he doesn’t think that’s actually likely for it to give up its ability to manipulate markets in any shape. Of course, it still happens, but it’s not intentional. However, investors should be aware that markets are complex and can shift at short times as extreme events bring extreme risks to financial markets. And it’s good to be well informed about these risks and practices so that investors don’t turn themselves into an actor in the stock market game.
Hearing investors say that they don’t understand how markets work is confusing because it suggests there is no explanation to trust and trust for markets, but merely mixed signals and randomly bounded thinking. We all, however, understand that these markets deliver specific goods in some forms, regardless of how complex they are. It is the characters of those traders that move markets at those specified times or in those specific ways. If we are able to understand a little better, we can protect ourselves better when we trade and therefore, instead of trying to follow markets, we can learn to find a better way to invest our money.
Hadden, H., and Kendrick, M. (2015). Q&A: The markets, management and the AIAG Guidelines. Cengage Learning.
Lee, S. (2008).