OT/Pat: Jan. 31st. Barron's: Maggot Therapy.The need for Day Traders.
Nice research Pat.It shows why
a) it is so difficult to trade/invest/on the basis of
predicting the direction of future markets
b) Day Trading is more productive.
From today's Barron's:
interactive.wsj.com
Maggot Therapy
Why day-traders are good for the market
By Gregory J. Millman Barron's Jan 31, 2000
A thing may be both loathsome and beneficial. Medical
writers noticed as long ago as the 16th century that maggots
devour dead or dying tissue and leave healthy tissue alone. Yet
it took Confederate medical officer J.F. Zacharias to put that
knowledge to practical use. Zacharias planted maggots on
soldiers wounded in the gruesome battles of the Civil War to
prevent gangrene and speed healing. He reported: "Maggots in
a single day would clean a wound much better than any other
agents we had at our command.... I am sure I saved many lives
by their use." Maggot therapy worked so well that by the early
years of the 20th century it was a standard part of medical
practice. Then the discovery of antibiotics made it obsolete.
But by the end of the century, hospitals began to use
Zacharias' maggot therapy again. Why? Because in addition to
eating necrotic tissue, maggots munch away on those infamous
new antibiotic-resistant bacteria that nothing else can kill.
Yes, a thing may be both loathsome and beneficial. That's a
lesson to keep in mind when the subject of day-trading comes
up.
Sure, there's plenty to loathe about a business that lures
clueless investors into risking more than they can afford to
lose playing momentary swings in the prices of stocks. It's a
business that flashed into the headlines last year when it
pushed a hapless high roller in Atlanta to the point of mass
murder.
Day-trading entrepreneurs as a group certainly don't deserve
any medals for nobility and selflessness, but we need
day-traders, pretty much for the same reason that we need
maggots. They do a difficult, unpleasant and necessary job
better than anything else can.
Trading Alternatives
Like a swarm of maggots feeding on diseased tissue,
day-traders have prospered and multiplied by gnawing away at
inefficiencies that slow and sicken markets.
Not so many years ago, corruption and collusion on the
Nasdaq market were endemic. Stocks were traded by a cozy
cartel rather than a dynamic, efficient, competitive market, so
share prices didn't reflect a genuine economic balance of
supply and demand.
Nasdaq market-makers had colluded to maintain wide bid-ask
spreads for stocks. So the early day-traders had found easy
profits in spread cutting -- buying for a little more or selling for
a little less than the market-makers. As more traders entered
the markets in pursuit of the easy money, they narrowed
spreads from a quarter-point or more to as little as one
sixty-fourth.
Yet the day-traders -- some of them, anyway -- were making
money. Notre Dame Prof. Paul Schultz, famous for his role in
uncovering evidence of collusion on the Nasdaq, studied the
performance of day-traders in a paper published in 1998.
"[They] do not have any more information than the
market-makers they trade against, and in many cases they have
less ...," he wrote, "but [they] still make money... . Unusually
fast or skillful traders may find [it] to be more profitable than
working for a Nasdaq market-maker."
Schultz attributed the surprising success of day-traders to the
fact that they were personally responsible for all of their profits
and losses, so they had a greater incentive to concentrate on
the market. In other words, they did a better job than the pros
because they worked harder.
Among the things they worked on were faster, cheaper ways
to trade. Day-traders had a hard enough time making money.
They didn't want to erode their already uncertain profits by
paying high fees to trade with market-makers on the latters'
proprietary SelectNet system. The only alternative to SelectNet
was an electronic communications network called Instinet.
Traders could use Instinet to hit bids, lift offers, open
confidential negotiations and see a dimension of the market
invisible to those without access to Instinet's screens. But
Instinet was dominated by market-making and brokerage
institutions -- and day-traders were not allowed to join.
The day-traders began to build their own electronic trading
systems. The first of these, Island, surpassed Instinet in
trading volume shortly after the regulators changed the
order-handling rules. It became the biggest market-maker for
Amazon.com, Dell, Yahoo, and other volatile stocks favored
by day-traders.
Because electronic communications networks bring together
buyers and sellers of stock, they compete directly with the
Nasdaq Stock Market and traditional exchanges, all owned by
professional middlemen.
But the prices at which stocks trade on ECNs may never be
seen outside of the ECN. So, it has become more difficult for
traders to know what is the best price in the market at any
given time. Thus, ECNs have been blamed for "fragmenting"
the market.
Evolving Solution
The market is unquestionably fragmented, and it is undeniably
a problem, but the technology to solve it exists and it's being
put to work. The ECN Archipelago, though its roots are in
day-trading, has attracted investment capital from firms like
E*Trade, Goldman Sachs, Instinet and Merrill Lynch precisely
because its open platform breaks through the barriers that
fragment the market.
Archipelago is linked to all other exchanges and ECNs and
searches the entire market in order to find the other side of any
given trade. <biEssentially, Archipelago links all of the discrete,
fragmented pools of liquidity into one continuous market
stream.
In September, Chairman Arthur Levitt of the Securities and
Exchange Commission took the Archipelago idea one step
further and proposed creating a "central limit-order book" to
display all orders to buy and sell stocks no matter where the
orders had been placed. It's a good idea, now that day-traders
have made the markets faster and more efficient.
Jim Marsden, executive director of the University of
Connecticut's Treibeck Electronic Commerce Initiative,
approves. "Using regulation to make markets efficient is costly
and not very effective," he says
In experiments conducted in the U.S. and Asia, Marsden and
his colleagues simulated a market influenced by insider trading.
The experimenters gave all traders in the simulation some
information, and handed a few traders a little more information.
If the people with inside information were caught using it, they
were penalized. But just as in real life, insiders could profit by
using their information unless the experimenters made lots of
random checks and imposed penalties that were sure and
severe. Marsden says the checks and penalties necessary to
curb insider trading in the simulation were too frequent and too
severe to work in the real world.
In another simulation, the researchers took a different
approach. They did away with all penalties and checks. They
allowed the people with inside information to trade on it. But
they also allowed all traders to see the pattern of all bids and
offers for stocks.
"The actual market actions of the insiders revealed the nature
of the information," Marsden says, and hawk-eyed traders
piled on so quickly that the inside information was almost
immediately reflected in the price.
Healing Markets
Unlike a lot of ivory-tower research, Marsden's experiment
makes sense on the ground. In fact, it's already working. Even
though the proposed central limit-order book is still little more
than a gleam in the SEC chairman's eye, institutional money
managers already complain that it has gotten harder for them to
execute big buy and sell orders at the prices they want.
They complain that day-traders watch the markets constantly,
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and have learned to spot the signs that signal a big order
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moving in, no matter how surreptitiously. The day-traders try
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to pile in or out of the stock according to the direction of the
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order, running prices up or down. That's bad news for the
----------------------------------------- -------------------------------
harried institutional manager, but it's great news for the rest of
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the market. A market where prices move quickly to reflect all
---------------------------------------------------------------------------
information is efficient and healthy.
------------------------------------------------
So, without any sense of altruism, selfishly pursuing their own
interest in the tradition of Adam Smith's Invisible Hand,
day-traders are helping heal the markets. If Wall Street
professionals compare them to maggots, it's sort of a
compliment.
Best of all, unlike regulation, day-trading is a self-limiting cure
for what ails the markets. The more efficient and healthy the
markets get, the harder it is for day-traders to make money.
Like maggots on a healing wound, the more they search, the
less they find. If the market were ever to get perfectly efficient,
day-traders would all die of starvation. Until then they'll be a
welcome, occasionally loathsome, fact of market life.
=====================
TA
Message #5620 from pat mudge at Jan 29 2000 2:14PM
A couple weeks ago I was really upset by David's glossing over his JDSU opinions so decided to refresh his memory. I found one positive post and then decided
it wasn't worth posting. However, since you brought up the subject, a few for the record:
October 10, negative:
beta.siliconinvestor.com
October 14, negative:
beta.siliconinvestor.com
beta.siliconinvestor.com
Oct. 27, negative:
beta.siliconinvestor.com
Nov. 3, sarcastic:
beta.siliconinvestor.com
Nov. 8, negative:
beta.siliconinvestor.com
beta.siliconinvestor.com
Nov. 22, positive:
beta.siliconinvestor.com
November 24, mixed;
beta.siliconinvestor.com
Nov. 30, sarcastic;
beta.siliconinvestor.com
Dec. 1, negative:
beta.siliconinvestor.com
Dec. 10, negative:
beta.siliconinvestor.com
Dec. 13, negative;
beta.siliconinvestor.com
beta.siliconinvestor.com
Jan. 11, negative:
beta.siliconinvestor.com
Jan. 12, negative:
beta.siliconinvestor.com
Jan. 15, negative;
beta.siliconinvestor.com
Jan. 16, negative:
beta.siliconinvestor.com
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