Speed Kills, and Can Kill Markets Too

Interesting stat by the NYSE.  Turnover in stock trading is down.  It’s been steadily dropping since 2007.  One reason for the increase in turnover back in 2007-2009 was the market crash.  Volume exploded and some people got out, some got in.  However, when all equity markets are figured in, turnover is significantly higher and isn’t looking back.

Part of the reason for the drop in turnover is there are more people executing the “buy and hold” strategy.  Eugene Fama’s efficient market hypothesis and Warren Buffett’s maxim of holding for long periods of time are finally taking root in the minds of investors.

Portfolio managers are being constantly measured.  They can’t win using higher turnover strategies.  Surfing the next trend will lose money in the long run.  We used to joke that corporations would manage earnings quarterly and the quarterly earnings call gave executives tunnel vision.  It seems like with the of information travel that Wall Street has changed the quarterly cycle to weekly.

There is absolutely zero chance for the average investor to be faster than the rest of the market. The only strategy that works is to research, make a plan, take action, and wait.  More pros I speak to are turning to options markets as the only way to get and hold an edge.

There is room for Fin Tech startups to come in and fill voids or create entirely new businesses.  Finance is over regulated, and it’s contained in vertical silos.  The problem is startup costs can be high.  But, the long term rewards can be huge.

Different forces are coming together to kill once vibrant marketplaces.

Dodd-Frank regulation has crushed some trading strategies.  Commodity futures clearing firms now are considered to be a systemic risk to the entire economy.   That ruling has increased costs for all traders.  Increased costs mean they can’t trade as large because they have to put more money up to hold positions.

In some markets, speed has helped killed the market.  Look at small specialized markets like the Lean Hogs($HE_F).  Open interest is down 50% YOY.  Open interest is a good sign of contract viability and health.  The hog contract looks as ill as the piglets that died last year from disease.

Why is it dying?  A few reasons.  The contract is mismatched to what the industry wants.  Futures contracts exist to manage risk, and the index doesn’t manage it.   Indexes mostly are good for creating volume and for brokers.  They generate commissions.  The Dodd-Frank effect has had outsize hurt on specialized contracts like the hogs.  But there are plenty of other contracts where this is the case.

The computerization of the marketplace has also hurt small specialized contracts.  It’s chased away liquidity providers.  The ones that remain trade smaller.  No one puts any “size” up anymore for fear of getting run over. When large hedgers come in that absolutely need to use the contract to manage risk, only the computerized traders are there, and hedgers can’t get volume off.  There is a lot of slippage.  In cattle($LC_F), sometimes markets go limit up or down when hedgers try to roll positions.  Several years ago, that wouldn’t have happened and they would have been able to roll without a ripple.  That dramatically increases all in costs despite what anyone might hear.  For smaller, retail Johnny One Lot traders, computerization of the boutique market has been awesome.

Computerized markets have gigantic outsize benefits to the entire marketplace.  But, I don’t think that exchanges or regulatory agencies have a clue as to how to administer and implement them so that markets do what they were designed to do.  Their “one size fits all” style of management has hurt the marketplace.  I think they also view the market from a “broker” perspective and not a “trader” perspective.  That is a tremendous difference.  Dodd-Frank is crippling the effectiveness of all liquidity providers.  Open interest, volume concentration, and the costs of doing business show that hurt.