According to the recent working paper listed below, changes in market
structure are one of the causes of increased volatility. I have not
read the paper yet.

http://papers.ssrn.com/sol3/papers.c...act_id=1297411
"Where Have All the Market Makers Gone? Evidence the Markets are
Becoming Less Efficient"
KURT W. ROTTHOFF, Seton Hall University
In 2006, the NYSE adopted the hybrid market, changing the role of
market makers. The added anonymity for traders makes it harder for
market makers to match large continuous order trades, leading to an
increase in volatility and a decrease in efficiency, because less
information is contained in the price of a stock at any given time.
Using a difference-in-difference estimation, both as an absolute and a
conditional comparison, with a variance ratio test, rolling window
test, event study, and GARCH estimation I find that market volatility
has increased in hybrid markets, relative to electronic markets as the
hybrid market was adopted. Although the hybrid market may increase
speed efficiency, it decreases informational efficiency.

On Nov 26, 10:18*am, "Andrew Koenig" <a...[at]acm.org> wrote:
- quote -

A wise man once pointed out that the forest is composed of trees.

PG in 2000 dropped from just under $60 to below $30 in about two
months. There was EPS disappointment and mistrust of management. By
the end of 2000, it was just under $40, spent all of 2005 above $50,
and hit a high in 2007 of $75.18. Today it is $64.

There are many similar stories of earnings disappointments, but the PG
story seems appropriate to today's markets.

The fun of doing a model portfolio is that one needn't be concerned
with realizing losses to raise cash, or paying taxes on gains, and, it
isn't real money to begin with. I'm putting together a model portfolio
of ten stocks, and pricing it on Monday. EMR, IR, MSM, FAST, CHRW are
sure to be in it. I'm thinking DD, T, CSCO, BP, FISV. And 1000 ODP
below $2 for the IRA speculation. (Note - these aren't
recommendations, just monopoly money.)

I want to discover for myself whether or not I am rational :-)

"Andrew Koenig" <ark[at]acm.org> wrote in message
news:eNdXk.43646$_Y1.7383[at]bgtnsc05-news.ops.worldnet.att.net...
- quote -

I hope you don't mind if I summarize.
Down markets feed on themselves.
Up markets feed on themselves.

The reason people will flock to a big sale at Macy's is because they are
pretty sure that is the lowest price they will see for awhile. With stocks
it's different. Markets uaually overshoot on both the upside and the
downside.


======================================= MODERATOR'S COMMENT:
Thank you for being succinct.

dumbstruck <dumbst...[at]gmail.com> wrote:
- quote -

"Momentum" across years and years is correctly known as "normal
economic growth."

- quote -

Shiller among others speaks about the business cycle being some ten
years. What you are talking about is short-term performance. Hence
many investors care not at all about a track record of a mere six
years.

On Nov 26, 12:08*pm, Douglas Johnson <p...[at]classtech.com> wrote:
- quote -

Joseph Schumpeter long ago described the economic cycles of "creative
destruction". He even predicted the end of capitalism due to the
inablity of folks to stomach this rough side effect of healthy
entrepreneurship: http://en.wikipedia.org/wiki/Joseph_...ism.27s_demise
. Thus there can be market crashes based on fundamentals.

I don't think fear by individual players is being ruled out, but the
thesis is that a greater (now overwhelming?) influence is being
wielded on the market by managers who accelerate trends based on
unfortunate but rational expectations. The last line of the executive
summary I posted has an unsettling conclusion for the future.

On Nov 26, 11:21*am, honda.lion...[at]gmail.com wrote:
- quote -

No, that interpretation of me and the article is incorrect. You can
just click on the article citations for an executive summary or the
paper itself (from "The Paul Woolley Centre for the Study of Capital
Market Dysfunctionality" which certainly wouldn't be trying to
whitewash a bad practice). Summary at
http://www.lse.ac.uk/collections/pau...%20Summary.pdf

They are explaining "investor beware", because there is good logic
behind the fine granularity moves that comprise a boom or bust. You
can choose to benefit by going either with or against this process (or
opt out), but this may be your chance to understand it rather than
fobbing it off as irrational psychology. As the authors said, it
springs from their frustration at being a value fund during the tech
bubble, and even after vindication of their value approach they came
to see the need and logic for momentum.

I AM NOT TALKING ABOUT OPPORTUNISTIC SHORT TERM MOVES, as you
repeatedly characterize my writeups. Momentum across years and years
can be a reasonable part of asset allocation, because at the heart of
it is a good fundamental story for some sector (eg. midcaps) or global
region that I can commit $ to for that fact alone, but then those
slower to recognize it pile on and on to accelerate returns. You may
miss the first third of the rise and absorb the first third of the
fall, but the middle third is easily in your pocket. This is how I
retired early and I don't see how any aware person can fail to use it
successfully as at least a bias in asset allocation.

For example how could a Fidelity investor possibly overlook
outperformance of their midcap Leveraged Company fund over 5 of the
last 6 years http://finance.yahoo.com/q/bc?s=FLVCX&t=my&l=on&z=m&q=l&c=^GSPC
In a slow, ladylike fashion it quadrupled while SP500 just gained
about half, and took over a growing part of my portfolio. Even the
downfall was slow enough to preserve significant gains by the same
momentum principles applied downward. Have done similar things with
various country funds, etc over long timeframes.

- quote -

No gambling or short term stuff, with 2 exceptions. Must to be ready
to exit fast because crashes can be quick and lengthy. The Japanese
bubble and the tech bubble never really recovered afterwards for buy
and holders. And more recently I pointed out the NEW need for timing
your entrance to avoid losing years of expected returns in the insane
fluctuations of a few hours. A blind buy order can and has led to
grossly overpaying for a SP500 or 20/30yr tbill position if you don't
shield the timing such as with etf limit orders.

dumbstruck <dumbstruc[at]gmail.com> wrote:

- quote -

It sure reads like stretching to maintain the notion that investors are
rational. Markets were overshooting centuries before there were indexes and
fund managers.

IMHO, the assumption that investors are rational is false on its face. How many
truly rational investors (not effected by emotions such as fear and greed) do
you know? I know this market scares me, even as I'm saying "stay the course". I
know I got greedy in 2000.

-- Doug

dumbstruck <dumbst...[at]gmail.com> wrote:
- quote -

I think all the authors are suggesting is that almost any action can
be argued to be in one's self-interest.

The article (and I imagine the paper cited) are excellent
justifications for further dabbling in timing using momentum tactics.
I say dabbling, timing, and momentum approaches are all irrational
approaches to investing.

If one wants to sleep at night, one bets on economies, not short-term
fluctuations.

- quote -

This enjoyment is like that taken from waiting for the next card in
blackjack. Gambling is this way. Investing is not.

On Nov 26, 5:59*am, honda.lion...[at]gmail.com wrote:
- quote -

Overshoot is proposed to be a rational process that is normally in the
self interest of participating investors in an article "Why do share
prices move relentlessly in one direction?" at
http://www.economist.com/finance/dis...ry_id=12652255 .
They say "a new working paper by researchers at the London School of
Economics (LSE) suggests that the momentum effect is still consistent
with the idea that investors are rational.". In fact they find it
harder to explain the mechanisms of eventual "reversion to the mean"
3-5 years later than overshoot.

I normally enjoy the cycles of momentum, but not at the crazy speed
and extent such as recent tech, oil, and financial bubbles. Maybe
modern active investment tools are particularly supporting the
rationality that the paper describes.

Andrew Koenig wrote:
- quote -

Andrew, you might be interested in reading George Soros's "Alchemy of
Finance" where he discusses his concept of "reflexivity" and applies it
to a few market scenarios where he made a bundle of money.
Engineer-types will recognize it as a feedback loop much like you're
describing. If you google reflexivity you'll probably find a lot of
stuff by Soros on this topic.

I think you're absolutely right, that drops can lead to drops and vice
versa. For lots of reasons, human behavior being one of them, the impact
of leverage being another. With banks recently there's this issue of low
share prices meaning high dilution when raising new equity-based
capital, a sort of death-spiral for equity holders during hard times
(not just with banks, though their capital needs are unique because of
the way they're regulated). Credit-rating downgrades trigger provisions
in debt covenants that put more stress on company cash flow, leading to
more credit-rating downgrades. The 1987 crash is blamed on portfolio
insurance and the resulting waves of selling. Many examples here...

-Tad

On Nov 26, 7:18*am, "Andrew Koenig" <a...[at]acm.org> wrote:
- quote -

Because no one can sell back to Macy's. Making this a comparable
situation, let's say I don't own any stocks at this time, just all
cash. Then yes I am definitely buying (fact is, I am buying
anyway).

"Andrew Koenig" wrote:
- quote -

Lately I think about the decline often in terms of, "How much of it is
based in panic, and how much is based in at least a crude calculation
of declining company earnings?" To me much of the decline is panic-
based, driven by what you say above.

- quote -

But ISTM that it has to be "influence" of such a quality that it has
to get to the masses of investors. Which to me means that, even if the
influence is simply a small change in investing philosophy, getting
enough of the masses to adopt this change is a tall task.

I see market panics as substantially psychological behavior. A
Darwinian model works. People are going to lose their shirts from time
to time. The more skilled will survive. It is the proverbial (for the
liberal arts crowd) shrinking sinusoidal curve of input-output (for
the techie crowd), such that society tends towards things getting
better overall, insofar as health and well-being are concerned.

A stray thought:

Usually when demand increases for something, that drives the price up, which
decreases the demand until the price stabilizes.

But this stabilizer seems to work in the wrong direction in financial
markets: When demand increases for a stock, that drives the price up, which
*increases* demand -- at least until it is obviously overpriced. When
demand decreases for a stock, that drives the price down, which *decreases*
demand, inducing more people to sell.

I've heard this notion expressed as follows: "Why is it that when Macy's
holds a sale, people rush to buy; but when Wall Street holds a sale, people
rush to sell?"

So if I'm right, investor behavior is a natural market destabilizer: Price
changes feed back into investor behavior, which tends to push prices in the
same direction in which they were already moving. More evidence for this
phenomenon is that when stock prices decline, there is invariably a huge
outflow from stock mutual funds to bond mutual funds.

In general, when a feedback loop causes instability, reducing the amount of
feedback will reduce the instability, often dramatically. When a PA system
starts to squeal, turning down the volume just a tiny bit will usually stop
it. Which suggests that one way to increase stability in financial markets
is to find a way to influence investor behavior in general -- and it
probably doesn't need to be very much of an influence.