Monday, May 16, 2011

Money-Making Speculators Must Stabilize Markets; Only Money-Losing Speculators Can Destabilize


"People who argue that speculation is destabilizing seldom realize that this is largely equivalent to saying that speculators lose money, since speculation can be destabilizing in general only if speculators sell when the currency (or commodity) is low in price and buy when it is high." 

~Milton Friedman, Essays in Positive Economics (p. 175)

The chart above illustrates Friedman's point. The blue line above represents commodity (or currency) price movements over time in a market WITHOUT speculators (due to a government ban on futures trading, e.g. onions), and the red line represents that same market WITH the fictional destabilizing speculators (as portrayed by the media and politicians) now being allowed to trade. For speculators to destabilize that market, they would have to make prices more volatile over time, and that is what the red line illustrates - there are greater price swings, and greater price volatility (both up AND down) WITH speculators compared to price movements over time WITHOUT speculators.

But saying that speculators destabilize the market above is also the same thing as saying that destabilizing speculators must BUY when the market prices are at a HIGH point (driving them up even higher) and must SELL when the market prices are at a LOW point (driving them even lower). And as we all know, buying HIGH and selling LOW is a sure way to lose money, and speculators can then only be destabilizing if they are LOSING money, as Friedman points out, and therefore the chart above can NOT represent reality.

Conversely, if and when speculators are making money, they have to be buying low and selling high, which would be the same thing as saying that they are stabilizing markets and reducing price variability. And the more "excessive speculation" and "unfair profiteering" they are accused of, the GREATER the role speculators play in stabilizing prices and markets.

Bottom Line: If speculators are making money, they MUST be stabilizing markets. If speculators are losing money, they MUST be destabilizing markets (fictional chart above). But speculators can NOT make money and destabilize markets at the same time.

20 Comments:

At 5/16/2011 11:03 AM, Blogger juandos said...

"the small cap universe is LITTERED with 3 day stock trading patterns like this.

there are traders who make their whole living playing situations like this
"...

Yeah morganovich I was also wondering about some sort of scenario similer to what you commented on...

Still even in the nickel stocks arena wouldn't one need many tens of millions if not hundreds of millions of dollar to make this work?

I don't really know, I'm just guessing...

 
At 5/16/2011 11:24 AM, Blogger efimpp said...

This comment has been removed by the author.

 
At 5/16/2011 11:27 AM, Blogger efimpp said...

exactly, morganovich!
that's the "greater fool" who pays the price, while speculator is both destabilizing and making money

 
At 5/16/2011 11:38 AM, Blogger morganovich said...

"I'll gladly lose $1 billion a month on the NYMEX if I make another $10 billion a month selling oil."

an precisely how do you propose to do that?

is this your ludicrous russian conspiracy theory again?

 
At 5/16/2011 11:44 AM, Blogger morganovich said...

"Still even in the nickel stocks arena wouldn't one need many tens of millions if not hundreds of millions of dollar to make this work?"

no.

it's all about leverage at a point.

find a $3 stock that trades 50k shares a day. that's only $150k in value.

step in and buy 20k shares at market when it's at a delicate point and off you go.

alternately, there's the tried and true "pump and dump" plan where you buy a ton of stock at a low price, then get some media outlet, newsletter, or broker to hype the story. (this is the whole motley fool business model).

there's a sucker born every minute.

 
At 5/16/2011 12:17 PM, Blogger Benjamin said...

Morgan Frank-

If you can believe aliens murdered Vincent Foster at the order of President Clinton, and the the CPI is purposely rigged to undercount inflation, then I can believe that MYMEX prices are sometimes gamed.

 
At 5/16/2011 12:25 PM, Blogger rjs said...

red line looks like a chart of oil price movements over the last 5 years

 
At 5/16/2011 12:26 PM, Blogger juandos said...

"it's all about leverage at a point.

find a $3 stock that trades 50k shares a day. that's only $150k in value
"...

Ahhh, obvious now that you explained in simple terms I can understand...

Thanks m....

 
At 5/16/2011 12:29 PM, Blogger Buddy R Pacifico said...

Where were the speculators a year ago? Accenture Consulting briefly traded at one cent on May 6, 2010 -- the day of the Flash Crash. ACN currently trades around $56.00 a share.

When markets are structured to move so fast that speculators don't have to buy: then liquidity is not available to stablize the price.

I wonder if there are speculative trading programs, that are waiting for the next Flash Crash, to buy at the absolute bottom? AAPL, IBM, GOOG, BRK at one cent; mmm.

 
At 5/16/2011 12:54 PM, Blogger arthurfelter said...

As a licensed commodities broker, I'd like to weigh in here. Morganovich brings up a crucial point: speculators can - and do - influence market price. I see it all the time. But as Morganovich pointed out (unknowingly, perhaps) that market influence from speculators does not last long. Especially in a liquid market like oil, speculators cannot influence the markets for extended periods of time (ie, >1-2 days tops).

 
At 5/16/2011 12:56 PM, Blogger arthurfelter said...

@Benjamin: "I'll gladly lose $1 billion a month on the NYMEX if I make another $10 billion a month selling oil."

In order to make $10 selling oil suggests you bought the oil at $1. In essence, you are buying low and selling high.

 
At 5/16/2011 1:08 PM, Blogger arthurfelter said...

I made a revision to the graph. Can someone help me understand why this isn't true?

http://i.imgur.com/SjsVU.jpg

The graph shows speculators (red) buying low and selling high, and at the high pushing prices up and above market prices sans speculators.

 
At 5/16/2011 2:51 PM, Blogger PeakTrader said...

“The market can remain irrational longer than you can remain solvent.”-John Maynard Keynes

"In the short run, the market is a voting machine. In the long run, it's a weighing machine."-Warren Buffett

Speculators tend to destabilize markets. They often buy high and sell higher, and when rational investors short the market, they often cause powerful short-covering rallies, sending the market even higher, sometimes to "nosebleed" levels.

 
At 5/16/2011 3:53 PM, Blogger PeakTrader said...

"Speculators can NOT make money and destabilize markets at the same time."

That's not necessarily correct, in part, because light buying, not heavy selling, can cause markets to fall much further (most of the sellers sold long ago, at much higher prices).

Heavy volume near or at market bottoms can be short-term traders taking advantage of greater volatility (for a trader, a volatile market is a forgiving market).

 
At 5/16/2011 4:18 PM, Blogger PeakTrader said...

Few sellers and even fewer buyers will cause markets to fall, and markets won't stabilize, until there are enough buyers to build a bottom.

 
At 5/16/2011 7:40 PM, OpenID Sprewell said...

I completely agree with Morganovich that some speculators can make money through speculation, in exactly the manners he details, but Mark's point holds that on net all the speculators as a group lose money. The key here is that the idiots who want more regulation claim to know how high is too high or how low is too low. If they're so smart, why don't they bet their money against the "speculators"? That's when you get a lot of stammering in response and they slink away. As soon as they have to put their own money where their mouth is, as opposed to someone else's tax money dumped down the SEC rathole, their indignation crumbles.

As for the smaller speculators who lose money cuz they got in late, that's the proper punishment for their gambling. My last roommate fit that pattern: no matter how many times I told him his "technical investing" charts were junk science, he'd keep gambling. Oh well, his losses will teach him eventually.

 
At 5/16/2011 10:30 PM, Blogger PeakTrader said...

"Speculators can NOT make money and destabilize markets at the same time."

That statement doesn't seem to be supported by the data.

For example, oil prices were around $10 in the late '90s, which reflected a lack of interest by speculators.

Oil rose to about $150, fell to $40, and then rose above $100 again, along with speculation.

Even at the low of $40, oil was much higher than the $10 before speculation.

 
At 5/16/2011 11:22 PM, Blogger PeakTrader said...

However, I agree with the chart that speculators will raise the price of a commodity, e.g. oil, so high, it will cause future consumption to fall and future production to rise resulting in a lower future price, i.e. than without speculation.

 
At 5/18/2011 8:55 PM, Blogger VangelV said...

The problem is not speculation but manipulation by speculators who use the agencies that are supposed to keep markets honest. We see that the silver market trades more ounces in an active day than the miners can produce in a year. According to the COT, most of the contracts are traded by four or less big players who can never deliver all of the silver that they have sold short. We have also seen similar manipulation in the copper and platinum markets. And the IMF and CBs tried to manipulate the gold market by using the London Gold Pool for quite a long time.

 
At 5/18/2011 8:56 PM, Blogger VangelV said...

I'll gladly lose $1 billion a month on the NYMEX if I make another $10 billion a month selling oil.

It is not that simple unless you get help from the regulators. If it were many people could become very rich by using the strategy.

 

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