April 26, 2017

Man vs Machine

If you’ve never been to Sedona, AZ in April, go but guard yourself because it will lay hold on your spirit and make it captive to unrelenting beauty.

How does the French election, yet unfinished, help US stocks?

Wait, no. It’s not the French election causing US stocks to soar, we’re told. It’s corporate earnings. Investors are loving good numbers.

Except investors didn’t set prices Monday when the market surged. Fast Traders did. The machines.

Saying the market is up because investors like Macron’s chances to win the French presidency reflects nothing fundamental. It’s an explanation fitted to an outcome.  Saying investors are gushing over corporate earnings is also finding a cause for an effect.

What data support the conclusion stocks jumped because people prefer the Frenchman Macron over the Frenchwoman Le Pen?  What data say investors are pouring money into stock because of strong earnings?  Earnings aren’t strong. They’re just better than weak results a year ago.

The data supporting those views, it turns out, is the market itself.  It’s up. So it must be that investors like something. The French election.  No?  How about US corporate earnings?  Market direction becomes a cause for humans, even when humans are not its cause.

Many suppose prices in the stock market can’t be set by machines. The opposite is true. Prices in the market can’t be set by humans. Under Regulation National Market System, it’s impossible for a human being to walk around the stock market trying to make a trade.

The rules say any “marketable trade,” a stock order wanting to be the best bid to buy or offer to sell, must be run by machines. Why? Because a human cannot keep pace with the market’s speed, and the order must be able to move fluidly to best price, So, the regulators said, it must be automated. Run by machines.

No matter where shares are listed, your stock can trade anywhere, from a private market operated by Credit Suisse, to the newest exchange, IEX.  The rules say simply that orders to buy and sell must move seamlessly to wherever the best price resides.

Well, humans devised machines with one purpose: setting price.  Humans themselves can set prices, sure. But they try to be in the middle, between the best bid to buy and offer to sell.  Yet we go on treating both events as though they are the same.

Understanding both the broad market and your own shares requires recognizing that while self-driving cars are a ways off yet, self-driving stocks are here now. When we all sit around talking about it, trying to find some rational explanation, we become weirder than the market. It’s as though we’re making excuses for the monster we crafted.

Since Fast Traders who want to own nothing set the pace, don’t be surprised if the pace disappears all at once.  And ask yourself every day: Are humans setting my stock price today, or is it the machines?  The answer is eminently measurable.

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