Monday, January 14, 2019

Who is the patsy in the stock market’s poker game?

December’s stock market decline bottomed at around 19% from September’s peak. On December 23, the trading volumes peaked resembling the ‘capitulation stage’ of bear market bottoms. All are considered expressions of extreme market emotions.

Why do market emotions play such an important role when nearly 60% of market volume is created by High Frequently Trading (HFT). Internet research show extremely nebulous numbers at best on this topic. But it was mentioned that the profitability of HFT has declined in the equity markets from a peak in 2012-13 when it made up nearly 60% of the trading volume.

Institutional investment volumes, including large trading entities that use sophisticated computer modeling programs in general has increased to make up nearly 90% of the market trading volumes. In the meantime, retail investors make up barely 10% of the volume.

How can all this machine driven ‘investment’ be considered to cause ‘market emotions’? After all, it is supposed to be driven by unemotional professional investment thinking. Are those computer models supposed to follow technical trading patterns or momentum trading that reflect traditional human emotions? Commitment of Trading charts based on option trading are often used to reflect ‘market sentiment’ by comparing the bullish versus bearish sentiments. Then there is the market volatility index or VIX that is supposed to indicate sentiment. The question is whose sentiment? And is it all driven by ‘Headline Risk’, i.e. the noise that is in the headlines of news media publications who make money by producing scary headlines? How reliable is that information and then the professional decisions based on that?

With all the sophisticated software that extrapolates share prices and governs most trading patterns you start to wonder how much of December’s market decline was driven by pure artificial notions embedded in exaggerated machine decisions? In other words, how much of December’s market decline was pure ‘fake’ created by the media and enhanced by institutions trying to make a quick buck?

This is like retail investors trying to out-think the thinking of institutions who try to out-think the hysterical media who try to out-think the human investors who have absolutely no influence any longer on market trading patterns! Is that contorted enough for you? What can we take away from this?

Well, here again is the old poker table analogy: If you sit at the poker table and can’t figure out who the patsy is then it is likely you. After all, where does all this money ultimately come from? Supposedly from us investors and contributors to pension funds. It is not that the banks and other investment institutions use their own money! That is our money artificially leveraged with Quantitively Easing cheap money to skim off money in addition to the service fees and low to no-interest paid on our bank deposits! Out of that, the fat cats take their share and the rest is split as dividends and stock market returns amongst us, the patsy! Sounds like a Ponzi scheme to me. There is no way as small investors that we can out-invest these sharks at their own game. There is only one way, regardless of market movement that we can make the money that we need to build our own assets and achieve financial adulthood. Don’t let the sharks manage your money! With pensions and bank deposits that is hard to avoid but you must learn to invest your savings without being skimmed!

Do you know how most people make money from their real estate? Right, by not selling it! You buy a property and sit on it until you have to tear it down or move out or turn it into a rental. You build equity in your real estate by holding on! How do many small business owners build up equity in their businesses? By holding on to a profitable endeavor for as long as their career. If it doesn’t work, you close or sell the business. The same should be true for the small investor. Let others make the quick buck or better: think they make the quick buck. We invest in profitable businesses – assets that over the long term make money in the form of dividends, rents or whatever other cash flow and benefits are derived from it. Those businesses can be our residence, our own company, our career, gold or stocks and bonds. We hold on forever, as trading is not for us.

We must make sure our businesses are profitable or we must eliminate them. When the market value of our businesses are going through the roof, it means that future returns on investment will decline while the risk of a price collapse increases. Thus, we are not greedy but willing to cash-in and move on. We use the proceeds when assets are on sale and we also use our savings to buy more assets. But, the less we sell the less taxes and commissions we pay. The less we trade the more likely it is that others who feed from our trading mistakes will suck less out of us and then we are no longer the patsy and the other players will have to fold!

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