Another week brings another round of political theatre on capital hill. This week's topic was the stock market "crash" of last week and had all the trappings of a game of "Clue". Who crashed the market? Was it the high frequency trading firms with their cadres of supercomputers? Maybe it was secretive dark pools with their "hidden" quotes? Or it could have been an individual trader who in between browsing the latest Ferraris online accidentally substituted "millions" with "billions". And if none of those turn out to be true, there is always Santa Claus and the Easter Bunny as they have yet to be called for Congressional testimony.
Congress desperately wants one these scenarios to be true for it would then provide them with a new bogeyman on the scale of a Goldman Sachs or British Petroleum. Consider the relative sound bite value of "High Frequency Traders are not only a parasitic tax on our financial markets but pose a grave and immediate threat to the very stability of our public markets" versus "The market declined because there were more sellers than buyers". Yet the latter is exactly what appears to have occurred and is the very definition of a market.
Contrary to Congressional belief and desires, markets were not designed to only increase in value. They are only supposed to rise when there are more buyers than sellers. This was not the case last Thursday and led to large but by no means unprecedented declines. In fact, even at the lowest point during the decline last Thursday, the S&P 500 was down less than 5% for the year - hardly a repeat of 2008.
Most publicity was focused on the trades for select large cap stocks and ETFs (Exchange Traded Funds, many of which hold diversified baskets of stocks) that occurred at or near $.01. A value that was clearly erroneous on the large cap stocks and that did not at all reflect underlying net asset values of the ETFs in question. These individual scenarios appear to have been the result of a high number of sell at market orders for these symbols being routed to destinations that did not usually trade many shares of these symbols. Because they were not the usual destination for trading in these symbols, when the sell orders arrived there were simply not any corresponding buy orders to trade against.
Think of a ticket scalper trying to sell tickets the day of the Super Bowl in Miami while standing outside of Yankee stadium. Do these tickets still have value? Absolutely, but all the potential buyers are in Miami, not in New York. Once routing resumed to the primary destinations, the values of the stocks and ETFs in question quickly rebounded as the sell orders were able to be matched with the corresponding buy orders.
These specific trades and symbols impacted by the above did not account for all of the overall index declines. Those were simply a result of a large amount of selling occurring at the same time. There were more sellers than buyers. Why? It does not matter. There are always numerous news items that can be pointed to - trouble in Greece, concerns about the Euro, rumors of liquidity issues in European banks, etc. All that matters is that more people wanted to sell than buy and that drove the prices down.
The irony in all of this is that less than 96 hours after the "crash" we had almost the exact same move but in the opposite direction as the Dow opened Monday morning nearly 400 points. Why? Same as before - more buyers than sellers. I'm still waiting for the Congressional investigation as to how the market could move almost 400 points at the open and who is to blame for it. Maybe the Tooth Fairy?
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