I like to think (it has to be!)
of a cybernetic ecology
where we are free of our labors
and joined back to nature,
returned to our mammal
brothers and sisters,
and all watched over
by machines of loving grace.
Richard Brautigan, Trout Fishing in America
Headlines during the current market decline have been nothing if not dependable — “plunge,” “meltdown,” “tumble,” “fear grips market,” “panic selling,” — we know all the catchphrases by now.
The typical narrative on the evening news or in the paper next day leads with some form of “Fear gripped investors Thursday…”
But are individual investors actually driving markets by making trades on these emotions?
They are not. These surges mark the rise of the machines: index funds that hold a massive amount of investments, all rolling in lock step as the Street reacts to programmed conditions. Ironically, the mechanized movements often reflect an irrational reaction to market circumstances, motivated more by fear than by carefully calculated opportunity.
The proof is in the predictable waves of activity.
For years now there has been an increasing tendency for large volumes of trades, and large moves in the market, to occur between 3:30 and the 4 pm closing auction. According to the Wall Street Journal, 23% of the volume in the 3000 largest stocks this year has occurred between 3:30 and 4:00.
With a market open from 9:30 am to 4 pm, an even distribution would suggest 7% of trades should happen every thirty minutes. And yet, in the final half-hour of the day, we are seeing more than triple the number of trades.
Friday, March 13th was a classic example. At 3:32 pm the S&P 500 was showing a gain of 2.26%. Fifteen minutes later that gain had lept to 6.1%, and the feverish rally continued through the closing auction, with the market finishing up 9.31% for the day.
Yes, somewhat paradoxically the President declaring a national emergency helped on that day. But the fact is that 20–25% of all trades happen in the last 7% of the day and have for years. This isn’t new. Here’s the trading volume from exactly two years ago, on March 14, 2018 via the WSJ:
On March 13th between 5–10 million trades were placed each minute, up until 3:31. From 3:32 onward, between 15 million and 77 million trades were placed every minute.
The great mass of humanity in America would have a hard time physically placing that many trades in the span of 60 seconds. But not the machines.
As the Wall Street Journal wrote last year,
Index-tracking funds often depend on buying and selling shares using the very last price of the day. Fund managers fear that if they miss a last-minute price move, they will deviate from the index or market they are supposed to track.
So the trillions of dollars in index funds chase the same trades in the frantic final minutes each day. In order to capture the 6% move in the market, they must buy shares…only, paradoxically, to push the price of those shares higher, thus pushing the index higher, thus requiring them to buy more. Caught in an endless loop, chasing their own tail, like the Ouroboros of Egyptian and Greek myth.
Index funds aren’t the only ones. Managed mutual funds, pension funds, institutional investors, trading algorithms, high-frequency traders, and computer-based program traders know that real action happens between 3:30 and 4 pm. Each acts in its own interest, but in aggregate all that trading activity can create a frenzied loop on days when the market is moving.
Why does this matter for the individual investor, trying to navigate a lifetime investment plan? Daily market activity is the interest of traders, not investors.
Patient, successful long-term investors tend to ignore narratives about the market’s daily moves, in the way that we ignore background music in a store or restaurant. But when the music, or in this case the trades get amplified they are harder to ignore. And they more they get amplified, the more likely we are to assign some meaning to the numbers.
In one of our great American novels, Blood Meridian, Cormac McCarthy writes
the order in creation which you see is that which you have put there, like a string in a maze, so that you shall not lose your way.
With millions of investors trading billions of shares each day, what is the likelihood that we find the string in the maze?
The great dream of the internet was the democratization of information and communication. The benefits accrued quickly. Slowly, but surely, we are also learning the dangers of this kind of connection, particularly on social media.
It is important to be able to understand, if not tune out, the headlines. In turbulent markets, the headlines typically reflect action amplified by the machines that take over in the last half-hour, without a shed of grace.
Trout Fishing In America by Richard Brautigan
Blood Meridian by Cormac McCarthy