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PERSONALLY, I AM UNACQUAINTED WITH THAT upstanding mug Nathan Detroit, but he nevertheless will be very happy to hear that the biggest floating crap game in New York is now legit, because it is being run on Wall Street. For that matter, the stock market lately has been more exciting than all the horses stabled at Aqueduct -- because it doles out winnings and losings faster than a scratch ticket. We are talking milliseconds.
The Street is now a casino because of heightened market volatility. Buying stocks today is like hopping on a Tilt-A-Whirl, with the Dow up 100 one day and down 100 the next. You step off feeling dizzy and whiplashed.
Eyeball the graph sent to me by Ken Safian, president of Safian Investment Research. It shows the one-week rate of change in the Value Line Index from 1990 to present. You are forgiven for mistaking it for a bottle brush, because the swings at the far right end are enormous, compared with the rest on the graph. "It's rare to see such volatility off the bottom, especially when the bottom was over a year ago," says Safian, a Wall Street fixture since the days of Ike.
He doesn't hesitate to finger high-frequency traders as the culprits -- hedge funds and the like that use powerful computers to game the markets and push stock prices up and down. These Fast Eddies are convenient fall guys, because they are secretive, mysterious, and behind an estimated 50% of all daily trades. But they aren't the only suspects. Agatha Christie might as well have penned this whodunit, because the list of possible offenders is long and includes you, me and the Internet.
I SPENT MORE THAN FOUR HOURS at a Securities and Exchange Commission roundtable Wednesday, trying to get to the bottom of the volatility issue. My conclusion: The market is so fragmented -- there are now 40 trading venues, including the traditional exchanges, new exchanges, automated trading systems and black pools -- where huge institutional orders are crossed off-market to avoid price disruptions -- that nobody has enough data to know exactly what is going on.
If there is a point of agreement among asset managers, market makers and academics, it's that most of the recent volatility is a result of investor skittishness. The high-frequency trading and dark pools are adding to the volatility, but not significantly. In fact, many experts think the benefits brought to the market by these players -- tighter spreads, lower commissions and greater volume -- offset any negatives.
"I think the volatility is a leftover effect from what we all experienced in the market over the past two years," says Michael Goldstein, a finance professor at Babson College. "Investors are skittish because of their experience in the recession. So they are quick to pull out of the market if something moves against them and quick to jump back in because they are afraid to miss a market rise."
Doug Rivelli, co-CEO of Pragma Securities, which runs a dark pool for institutions, told me over the phone, "There's significantly more volume than 10 years ago. The spreads are narrower. The markets are quicker. Access to information is quicker. Technology has given us the ability to react to that information more quickly."
High-frequency traders add to the fundamental volatility, says Sal Arnuk, a partner in Themis Trading. "The velocity of trading has accelerated timelines of cycles, of ups and downs; so that what might have taken three years to correct [in the past] is now corrected in a month," Arnuk says. The amplification, he says, is most pronounced in smaller stocks, where high-frequency trading often is predatory and market-destabilizing.
Traders, Arnuk adds, employ special perks -- data from exchanges and alternative trading systems -- that give them a market advantage. "It's patently unfair," he says. He told the SEC that the markets are rigged.
THE EXPERTS THINK THAT THE EXTREME volatility will dissipate over time as world economies recover from a period of instability. Nevertheless, the SEC plans to implement new rules to sop up that additional volatility and prevent another flash crash, like the one of May 6. Experts suggest a central order book, so pricing data from all venues is visible, and even a speed limit for trades -- say 10 milliseconds -- so that California investors 19 milliseconds away aren't disadvantaged for not having a computer next to a New York Exchange.
Until something is done, there will be many days when the market feels like...a casino. "Do we want a casino, or do we want something that fosters longer-term investment and capital formation?" asks Kevin Cronin, director of Global Equity Trading at Invesco. "Once you have that nailed down, you can determine how to govern the markets."
Regulators, get out your hammers.
E-mail: jim.mctague@barrons.com
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