If this volatility continues, Wall Street may lose Main Street and the economy will be worse off
Lots of people are blaming computers and so-called high frequency trading for the insane stock market fluctuations we've seen over the past week. But that's not quite right. Sure, technology is making the dramatic ups and downs possible, but the computer is a mere tool. Even since big investors stopped worrying about company fundamentals and became involved in technical analysis and tricky arbitrage strategies, the stock market fundamentally changed.
The Real Cause of the Problem
The problem with blaming big market fluctuations on computers is sort of like blaming guns for murders. As the saying goes, "guns don't kill people, people kill people." Similarly, computers don't cause crazy volatility, the people who operate and program those computers cause crazy volatility. This is evidenced by traders' love of technical analysis. David K. Randall from AP explains:
Technical traders all but ignore fundamentals, such as corporate profits or expected growth rates. Instead they rely on stock-chart analyses that signal when to buy or sell the entire U.S. stock market.
In the absence of clear signs about the economy's direction, more of Wall Street is turning to technical trading. When the charts say "sell," a herd of sellers emerges, magnifying declines. If prices fall far enough, another wave of technical selling is triggered and the decline is intensified. At some point, a threshold is reached where the charts say "buy," and stock prices get whipped higher.
Wall Street no longer views the stock market as a means to invest in companies that they believe are undervalued based analysis of a firm's earnings and growth potential. Instead, it has become a sort of game. The objective is to find ways to buy or sell stocks and make a quick trading profit. Instead of representing companies, these stocks might as well represent race horses. So long as theories of trading patterns could be developed, it wouldn't matter what lies beneath a ticker symbol.
Tuesday's big gain epitomizes this point. It had nothing to do with investors feeling better about the economy or the companies that saw their stocks rise. Instead, some figured out a clever way to lock in ultra-cheap dollars to buy stocks based on the latest Federal Reserve policy. Once the rally began, the other lemming traders (or more likely computer algorithms) followed.
The Gulf Between Wall Street and Main Street Widens
Because of the stock market's evolution, Americans don't have a chance investing as amateurs. Sure, they could just buy an index fund and do okay. But if the computers powered by technical traders take over, they could see their nest eggs shrink by thousands of dollars in minutes for no tangible reason. How long can they reasonably be expected to endure the fear this would cause? It's easy for a trader on Wall Street to shrug off a 5% loss on a day, because he or she is trading other people's money. It's not as easy for a Baby Boomer hoping to retire in a few years watch the losses rise and assume the market will just go back up eventually.