Hi David; I enjoyed your post, I would like to kick the idea down
the road some. I'm afraid I'm not ready with the words needed
to make the part I want as clear as I would like it to be.
I found that if a person has a big equation and solves for one part
(sometimes the easiest part,) then the rest of the equation becomes
more simple. There are diversities of all kinds , many the average
trader never sees. The one I think will make the equation simpler
and one that I'm sure impacts the market very strongly
is the S&P500 Futures, I think they are called Spoos. I don't
trade them but have watched them trade a lot.
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While I'm aware that most of the trading in Spoos is by Funds
that track the S&P step for step, similar to the spider SPY,
however also a lot of mutual funds have been born in the last two
years that do the same thing.
Roughly; They use an arbitrage system of program trading that calculates Fair valve of the Spoos based on what they can borrow
money at, less the dividend of the S&P to find the F.V.,
then if the futures get 33% above that they sell the futures,
and buy a basket of stocks, also the other way around if futures
drop below FV about 33% they sell a basket of stocks to buy the
Futures. It's sort of like what is it cheaper to own on margin ,
the stocks or the futures. this is just a rough outline,
to get detailed it would be to lengthy and many readers would
get turned off. ( Spoos are the S&P Future contracts )
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This type of trading has a focus that when the Stocks are bought
and sold the ones with the highest market cap are traded more
than their little brothers. This creates what I often term the
Mo Mo, ( momentum stocks ) in up markets the big caps have to
be bought not based on FA value but primarily on market cap
in order for the funds to track the index. Stocks that
by way of hook or crook have gotten their market cap up become more
and more the beneficiary of the effect. Then for them to sell
down it drops the index and that can force all stocks down,
as people worry about getting out of the thinner traded stocks
they most often sell off to a greater extent.
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What I driving at is Stocks do not trade on their own merits,
and the effect of the Cap weighted index causes a large commingled
effect with big caps dominating the actual over all trend.
This effect has greatly increased in the last two years, and
without some basic changes in the rules of how program trading can be carried out it will get more prominent in the future.
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I'll add more later, but if we put politics aside..and look at
the mechanics of this it's ironically Communistic, and has defeated
the based on merit system with stock value floating in a free market,
more ironic is the fact that the persons who created it are
the same ones who hate communism.
Jim
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