By trend trader, whose aim is to fine tune tools and examine critical economic and industry data to help himself and others navigate the rise and fall of equity and currency markets. Via Macrobusiness, originally published at tradersrant.
… aka, equity market agents and non-linear dynamic behaviour.
Inspired by reading Professor Steve Keen’s book on ‘Debunking Economics’, this is a first pass at quantifying what many call the ‘herd’. Understanding herd mentality/crowds/group behaviour is a cornerstone to successful investing. In my (slow and winding) path of development of a better toolset for analysing price history for investment decisions, I have a string of projects that are effectively Engineering applications to the field of economics.
Not many books can be picked up and read that leave you with an appreciation of the subject, it’s power, limitations, history and the subjects internal professional biases. Steve’s book is all that for non-economists such as myself. It isn’t hate mail – it is a qualified professional taking stock of his life’s study. In doing so, Steve does a nice job giving the reader every opportunity to research and verify for themselves his own expert opinions on why mainstream economics can be, and is often, dangerous. Better yet, his book provides practical solutions that better describe day to day economic observations, at least to this Engineer.
I come to this point not from browsing news-stands, but having spent the past 2 years completing my own hands on full time private trading education having scoured libraries and universities for material that helped explain what was reportedly ‘unprecedented, unforeseeable, unexpected and unpredictable’ market volatility not seen since the Great Depression of the 1930′s. What I have since discovered for myself is completely the opposite. What we are living through is normal volatility that has existed in the markets for over 100 years that is not unprecendented and most certainly IS foreseeable, expected and (to a large extent) predictable.
Volatility is inherent, innate and natural behaviour of dynamic systems and should be expected, and thus planned for. Many days were spent in libraries perusing journals of popular brand name economists searching for that elusive being who could explain dynamic disequilibrium to a simpleton. None qualified, so I have since developed an effective way to monitor, analyse, trend and model the dynamics of prices with using only an Engineering toolset. The success of this approach filters all the noise of misleading and costly distractions brought about by false explanations.
Professor Steve Keen’s book ties in all the important economic themes necessary for non-economists to make sense of what main stream ‘bookstand’ economists fail dismally at i.e. modelling instability and disequilibrium. His consideration of the history of economics and the major unorthodox contributors of past leave the reader with an appreciation that Steve cares about his profession and is determined to contribute to a better understanding of the subject matter.
Hence, a good application of my newfound knowledge would be explaining the periodic volatility that has existed in 100 years of Dow Jones Industrial Average since 1896 and most likely since it’s inception. In an attempt to quantify the equity market herd/crowd, I extracted the top listed shareholders of the 45 largest public listed US equities in NYSE, NASDAQ and AMEX exchanges. The top shareholders were simply the public listed top 5 individuals (persons), top 10 institutions, and top 10 mutual funds. APPL, XOM, MSFT, WMT etc and down the list ranked by market cap. I stopped at 45 for no particular reason.
The results:
- 45 stocks, $6.65Trillion current market cap; top shareholders are –
- 140 unique individuals (persons), holding 2.4% of this market cap
- 97 unique institutions, holding 18.4% of this market cap
- 139 unique mutual funds, holding 6.2% of this market cap
All told, 386 unique stock holders with different strategies, objectives, expectations and preferences hold just 27% of $6.65Trillion held in just 45 stocks.
According to the World Federation of Exchanges, the US equity market cap is of the order of $17Trillion (in round numbers) in several thousand listed equities. Extrapolating by crude approximation only – given the expanding number of smaller stocks to remaining and more numerous smaller holdings, it is not a stretch to estimate an additional 3x the above numbers for the remaining US equity market. Remember the above are considered only the major shareholders.
So something of the order of 1,000 unique entities actively control the lions share of $17Trillion in US equities. Economists call these ‘agents’, traders call them ‘the herd’ or the ‘crowd’. Volume is the crowd, the price is the common language. The price history of an asset accurately reflects the movment of the crowd – whether you happen to agree with it or not.
“Debunking Economics’ proposes a more accurate reality in the aggregation of multiple supply/demand curves (expectation curves I call them) to be non-linear. This non-linearity is modelled on a daily basis in technical analysis of asset prices, and is evidenced in over 100 years of the DJIA price history. So it stands to reason herd behaviour is in fact the real form of Steve’s non-linear aggregation.
Aggregating 1,000 unique investment expectations (agents) is no easy task. However ‘herd mentality’ permits some crude approximations in probably 6 groupings of tactical strategies linking similar behaviours (by my estimations). These are value/growth investors (buy and hold types), pensions/endowments, institutions, individuals/private equity, speculative traders and algorithmic/high frequency (millisecond) trading.
I am enthralled in reading Keen’s book ‘Debunking Economics’, as it is well written, and provides sufficient introductory and supporting material to help non-econmists come to terms with a difficult and misunderstood subject. It joins the list of few reference manuals to be kept within arms length. It should be a text book for anyone interested in reading economic theory.
The reading of ‘Debunking Economics’ better enlightens me on what market effects agents like Bernanke, Summers and Lagarde et al might like to think they can impose. In the end, these players live in hope to influence the crowd, for the dynamics are well and truly baked into the equity cake. QE1 and QE2 has been crowd control, full stop.
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First paragraph repeats itself
I want to know this:
what is the definition of “market”, economic formal definition. Certainly there should be minimal amount of players, buyers, minimal quantity of objects to be traded, and unit of exchange.
Is NYSE a “market”? If there is monopoly by few big investment houses. How do we know a market is a market, not just a sham? (I am pretty sure OTC swap market is not a market)
at any rate, how do they know if a market is rigged or not. Is there formal definition. Otherwise…all this currency, interest rate, exchanges, etc are all sham. all those economic/market theory are a sham, they can’t even definite the most basic condition of trade.
This is kind of a weird piece. It feels a bit like an advertisement, and I’m being polite.
I get it at the end, but all that stuff in the middle? Good luck with that. I knew it was only a matter of time before someone trading at human timescales figured out how to beat the market.
Really? Has NC sunk this low? Full on advert.
His next piece, on this menu, is even weirder.
Whaaat? Are you sure this piece shouldn’t have gone to Zero Hedge? I can imagine it as one of those ‘infomercials’ appearing in the header over there next to ‘Phoenx Capital’ but I can also imagine the readership totally ripping it a new one.
Thinly disguised uninformative, and even worse, poorly written/edited tripe in praise of Steve Keen (whose writing by the way I tend to hold in somewhat higher regard than the insipid soma peddled by 99% of mainstream economic hacks these days).
True. Not up to NC’s empyrean standards, I’m afraid.
I suspect this post is nonsense but I cannot be certain because it is impossible to understand what the writer is driving at. As for herd behavior, Keynes described it perfectly- the equity market is a beauty contest in which the idea is to determine which contestant will be found the prettiest by the judges having the most votes. Ben Graham understood that the judges are plagued by alternating bouts of exhileration and depression, are in fact manic depressives. Knowing these two things allows ordinary people to make money providing they have enough courage and do not take excessive chances and do not attempt to apply leverage. You have to avoid pie in the sky, buy quality when the herd is selling and sell it when the herd is chasing it, understanding that the market can remain irrational longer than you can remain solvent.
“…understanding that the market can remain irrational longer than you can remain solvent…”
Yeah. My favorite example is a small mutual fund I used to hold, Crabbe Huson Special. The guy knew that dot com was dot con way in advance, but because he called it too early the fund had to close.
In 1983, R. Earl Hadady applied a similar analysis to commodity futures. He sought to determine when a bullish trend would end, by looking for clues that long positions were held primarily by small traders, while short positions were increasingly gravitating to the strong hands of deep-pocketed commercial interests. His book is called Contrary Opinion:
http://www.amazon.com/Contrary-Opinion-Trading-Commodity-Futures/dp/0961139005/ref=sr_1_sc_3?s=books&ie=UTF8&qid=1333975410&sr=1-3-spell
Various public and private surveys, including the Commitment of Traders report, still collect this sort of data. Similarly, data on mutual fund inflows, outflows and cash positions is published. Such data may provide some incremental value. But “trend trader’s” naive notion that it represents a magic key to the markets is the product of his admitted inexperience (two years as a trader).
After twenty years as a trader (assuming he lasts that long), ‘trend trader’ may realize that there aren’t any magic keys to the market just lying on the sidewalk for a casual researcher to pick up, take home, and use to get fabulously rich by day trading.
If he harbors dreams of turning ‘tiny to trillions’ (as the floor traders say in the Chicago pits), ‘trend trader’ should try Mega Millions … and then use his pile of loot to hire an editor, or at least an English tutor.
As the old joke goes, “When I started skool, I couldn’t even spell ‘engineer.’ Now I are one!”
Ever since I developed a political consciousness I have known that the purpose of the system is to perpetuate the system. And when I read this quote in college I thought, well duh. We have a system, a capitalist system, that works in fits and starts. No one understands it so they call it a free market, or a herd mentality, or going nonlinear. But nobody approaches the subject by admitting that it has never worked for any but the already rich because they define capital as money wealth. Nobody has looked at how it should evolve to benefit all the people. So far free market capitalism has not been a path to prosperity, sorry Larry. It has been a path to utter chaos. If free market capitalism is the only choice you are given you start to panic big time when chaos begins to go exponential. You put your money in what you think will save you in a dysfunctional world. That just makes the chaos worse. But what about worker capitalism? How about environmental capitalism? Social capitalism? Right now we are all being held hostage to a system based on fossil fuel petro-dollar capitalism. Clearly, we do not know what we are even doing. And Steve Keen is right. Exponential private debt has done us in. Not simply because we are drowning in debt, but because our system is based on the free flow of money. Money capitalism.
So when debt overtakes money capitalism…. what the hell do you have? I really like the insight here the other day from a reader who posted a blurb in German to the effect that debt is of no consequence and should be forgiven because it was created out of absolutely nothing (pure speculation) in the first place.
“Nobody has looked at how it should evolve to benefit all the people.”
I have.
Geez. I had been encouraging Yves to do book reviews on NC – she gives us one, and you guys freak. Have any of you read Econned? Don’t you see Keen’s debunking as following that trend? Here we have a trader – a trader – suggesting that Keens dynamic models have real world application. Can you say that about IS-LM?
When is Yves back from vacation?
I appreciate the spirit that causes someone to use their free time over a few years to study a topic. That requires some dedication. So does raising a disabled child.
Managing 15 posts since January 3rd on a blog, 10 of those in the first month, shows a declining interest. Probably as it should be. But, really, does this dedication and development merit re-posting at NC?
On the face of it, no.
This was truly a terrible waste of time.