On Jan 9, 2009, at 7:10 PM, R C Macaulay wrote:
Howdy Vorts,
Anyone have a handle on what is referred to in the stock market as
"dark pools" ?
Are they engaged in "forward selling" that may be the cause of the
weekly uppity-downs in the Dow?
Sum'tin tells me that there are some people out there a whole lot
smarter than Jim Jubak.. well.. err.. unless he's one of them.. hmmm.
Maybe PT Barnum knew his circus business was a circus.
Richard
See:
http://en.wikipedia.org/wiki/Dark_pools_of_liquidity
and various other articles about them accessible through google.
I wrote about them here in 2008:
On Feb 9, 2008, at 4:32 AM, Horace Heffner wrote:
Within the context of the mortgage industry debacle precipitated
financial crisis it appears there is something even more sinister
making for the crazy markets:
http://tinyurl.com/3czmpr
Actual URL for above:
http://www.forbes.com/home/opinions/2008/02/06/croesus-chronicles-
darkpools-oped-cz_rl_0207croesus.html
The quants and their systems may be unintentionally setting up the
world markets and financial systems for a crash. Automated
arbitrage systems appear work fine until an underlying market
fundamental changes, like sudden changes in the the value of real
estate or some set of commodities.
The problem with modern portfolio theory is its fundamental
assumption, that the market activity is actually based on
stochastic processes. It is assumed that all fundamentals are
known by all the participants and very quickly "priced into the
market". All that is left is due to random fluctuations. I think a
large part of the variance in the random distributions is not
random at all, but rather merely due to variables and functions not
understood, but which test well for being random distributions. An
example of this might be the effects of a feedback loop between
publications (reporters) and politicians, and further, the changes
in cycle time, amount, quality, distribution, and uncontrolled
distribution of information brought about by the internet.
Of greater concern is the fact market transactions are increasingly
instant computer trades rather than trades by open and manual
bidding systems. This vastly increases the "velocity of money"
within the market place in times of a crises, and the velocity is
further increased when the buyers and sellers are mostly computers
too. We are moving toward the point where the ultimate crash
could take place in seconds.
The velocity of money V is the average frequency with which a unit
of money is spent, the dollar turnover rate, the frequency of
dollar spending per unit of time. For a discussion of the velocity
of money see:
http://en.wikipedia.org/wiki/Quantity_theory_of_money
and also see:
http://en.wikipedia.org/wiki/Velocity_of_money
There you'll see Milton Friedman's famous equation:
M*V = P*Q
V = P*Q/M
where M is the money in circulation, and P*Q is the gross domestic
product, the sum of the values of all transactions in a given
period of time. The value of a transaction is the unit price time
quantity for the transaction. This is expressed in the equation of
exchange:
M*V = Sum[i=1,n] p_i*q_i
In a computer generated crash, a huge amount of the world's capital
can cycle around between multiple investors instantly, i.e the
velocity V -> inf. Let F represent the values of all non stock
market transactions:
F = Sum[i=1,x] p_i*q_i
and G represent the sum of the values of all stock market
transactions:
G = Sum[i=x+1,n] p_i*q_i
This means
V = (F+G)/M
and if F remains fixed, yet the market transaction values for some
period go toward infinity, then we have as:
as G -> inf, V -> (F+G)/M = (F+inf)/M = inf/M = inf
This means
V = P*Q/M -> inf
if
G -> inf
i.e. the velocity of money goes to infinity if the velocity of
money in any subset of the economy goes to infinity. Since the
quantity of goods Q would remain fixed in the final seconds of
collapse, it rigorously must be that, since P*Q/M -> inf, either
(or both):
P -> inf, or M -> 0
and neither case is good. Such a collapse can, however, be
triggered by a sudden reduction in Q, through the collapse of
derivatives, e.g. futures contracts, which are in effect
commodities manufactured from nothing, yet which require real money
to buy. If I have this right (and I am definitely not an
economist!) in the end either price goes toward infinity, or money
supply goes toward zero, or both. Since we are in a global
economy, this appears to apply to the global money supply.
It is now of concern that, unlike the way things unfolded in
1929-1932, a total market collapse, as well as the bankruptcy of
many brokerages, arbitrage houses, and banks, could be almost
completely over before even a hint of it ever hits anyone's
screens. The only effective means of insurance is to be pre-
positioned at all times.
