tag:theconversation.com,2011:/fr/topics/nyse-7168/articlesNYSE – The Conversation2020-08-11T20:13:14Ztag:theconversation.com,2011:article/1429812020-08-11T20:13:14Z2020-08-11T20:13:14ZInsider trading has become more subtle<figure><img src="https://images.theconversation.com/files/352123/original/file-20200811-16-wlmz2d.jpg?ixlib=rb-1.1.0&rect=280%2C178%2C2223%2C1045&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Michael Douglas in Wall Street: Money Never Sleeps (2010)</span> </figcaption></figure><p>Insider trading comes in two main forms: arguably legal and clearly illegal. </p>
<p>But, as with drugs in sport, it’s hard to tell when arguably legal ends and clearly illegal begins.</p>
<p>It is generally accepted that it is wrong to buy shares in the company you run when you know something about it that the market does not.</p>
<p>It’s especially wrong to buy shares when you are telling the market that things are much worse for the company than you know them to be.</p>
<p>But what about suddenly sharing everything – an avalanche of information – in the lead-up to a share purchase in order to muddy the waters and create enough uncertainty to lower the price?</p>
<p>Chief executives have enormous discretion over the tone and timing of the news they release, generally answering to no one.</p>
<p>A linguistic analysis of twelve years worth of news releases by 6764 US chief executives just published by myself and two University of Queensland colleagues in the <a href="https://www.sciencedirect.com/science/article/abs/pii/S0378426620300881">Journal of Banking and Finance</a> suggests they are using this discretion strategically.</p>
<p>Not clearly illegal (how can oversharing be illegal?) their behaviour can have the same effect as talking down their share price while buying, something that is clearly illegal.</p>
<h2>Spreads matter, as well as signs</h2>
<p>Earlier analyses of insider trading have looked at only the “sign” of the information released to to the share market. On balance was the tone of one month’s news releases positive or negative?</p>
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<a href="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/352121/original/file-20200811-22-pl09o5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Spreads matter as well as signs.</span>
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<p>We have looked at the “spread”, the range from positive to negative as well as the net result. </p>
<p>It doesn’t make sense to treat as identical a month’s worth of releases which are all neutral tone in tone (sending no message) and a month’s worth of releases of which half are strongly positive and half are strongly negative (stoking uncertainty).</p>
<p>Our sample of discretionary (non-required) news releases is drawn from those lodged with <a href="https://web.stevens.edu/hfslwiki/index.php?title=Thomson_Reuters_News_Analytics">Thomson Reuters News Analytics</a> between January 2003 to December 2015. It includes firms listed on the New York Stock Exchange, the AMEX American Stock Exchange and the NASDAQ technology-heavy exchange.</p>
<p>The archive scores the tone of each release as positive, negative or neutral.</p>
<p>We used the <a href="https://www.thomsonreuters.com/en/press-releases/2014/thomson-reuters-starmine-model-predicts-us-stock-performance.html">Thomson Reuters Insiders Filing Database</a> to obtain information on chief executive buying, limiting our inquiries to significant purchases of at least 100 shares.</p>
<h2>Strategic uncertainty</h2>
<p>About 70% of the chief executives proved to be opportunistic traders in the sense that they bought with no particular pattern, rather than at the same time every year.</p>
<p>We found that news releases by these chief executives increased information uncertainty by 5.8% and 3.6% in the months before they bought and in the month they bought.</p>
<p>In the months following their purchases, the positive to negative spread of their news releases returned to the average for non-purchase months.</p>
<p>The unmistakable conclusion is that their behaviour is strategic.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/insider-trading-is-greedy-not-glamorous-and-it-hurts-us-all-60792">Insider trading is greedy, not glamorous, and it hurts us all</a>
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<p>We obtained similar results when we used other measures of buying and the tone of news releases.</p>
<p>Our results provide no evidence to support the contention that chief executives behave in this strategic way when selling shares. This is consistent with other findings suggesting that the timing of sales is often out of the hands of the sellers.</p>
<p><a href="https://scholar.google.com/scholar_lookup?title=Insider%20trading%20and%20voluntary%20disclosures&publication_year=2006&author=Q.%20Cheng&author=K.%20Lo">Previous studies</a> have found only <a href="https://scholar.google.com/scholar_lookup?title=Voluntary%20disclosures%20and%20insider%20transactions&publication_year=1999&author=C.F.%20Noe">weak links</a> between executive share purchases and the news they release to the market. This might be because those studies have looked for more easily detected (and more clearly problematic) negative news releases.</p>
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<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/to-protect-markets-we-need-strict-penalties-for-insider-trading-70191">To protect markets we need strict penalties for insider trading</a>
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<p>But that’s an old and (with the advent of linguistic analysis) increasingly risky approach.</p>
<p>Our research suggests that by saying many things at once chief executives can achieve much the same thing.</p><img src="https://counter.theconversation.com/content/142981/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Barry Oliver receives funding from the Australian Government</span></em></p>Chief executives have moved on from buying while spreading bad news. They’re buying while spreading uncertainty.Barry Oliver, Associate Professor, The University of QueenslandLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1336712020-03-16T17:22:40Z2020-03-16T17:22:40ZShould Trump shut down the stock market? 4 questions answered<figure><img src="https://images.theconversation.com/files/320828/original/file-20200316-27643-1txeft.jpg?ixlib=rb-1.1.0&rect=101%2C109%2C4750%2C3193&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The normally busy floor of the New York Stock Exchange was empty on Oct. 29, 2012, during Hurricane Sandy.</span> <span class="attribution"><span class="source">AP Photo/Richard Drew</span></span></figcaption></figure><p><em>Editor’s note: Financial markets across the globe <a href="https://www.cnbc.com/2020/03/16/stock-market-today-live.html">have plunged repeatedly</a> in recent weeks over concerns about the growing economic toll from the <a href="https://theconversation.com/us/topics/covid-19-82431">coronavirus pandemic</a>, on some days falling over 10%. This has <a href="https://www.wsj.com/articles/nyse-braces-for-coronavirus-with-potential-trading-floor-closing-11584009014">raised the question</a> of whether governments should shut down their stock markets until the panic subsides. We asked <a href="https://www.linkedin.com/in/jonathan-fluharty-jaidee-1650982b/">Jonathan T. Fluharty-Jaidee</a>, a finance expert at West Virginia University, what measures financial exchanges have to stem panic selling and whether he believes a shutdown would be a good idea.</em></p>
<h2>1. What measures prevent a free fall in prices?</h2>
<p><a href="http://dx.doi.org/10.2139/ssrn.3120370">Most financial markets</a> around the world have so-called circuit breakers that are triggered when overall prices drop by a certain magnitude. </p>
<p>For example, <a href="https://www.sec.gov/oiea/investor-alerts-bulletins/investor-alerts-circuitbreakersbulletinhtm.html">if the price of the Standard & Poor’s 500 index falls 7%</a> from its previous close, trading of all stocks on the two major U.S. stock exchanges – the New York Stock Exchange and the NASDAQ – is suspended for 15 minutes. If it drops an additional 6%, trading halts for another 15 minutes. If the S&P 500 drops a further 7% – for a total drop of 20% – then trading ceases for the day. </p>
<p>A 7% drop has happened <a href="https://www.reuters.com/article/ice-circuitbreakers/ice-circuit-breakers-aim-to-stop-trading-gone-wild-idUSL2E8ECCPD20120312">several times</a> in the current crisis, <a href="https://twitter.com/NYSE/status/1237087591826153472">most recently just three minutes into trading on March 16</a> following the Federal Reserve’s <a href="https://theconversation.com/the-fed-will-have-to-do-a-lot-more-than-cut-rates-to-zero-to-stop-wall-streets-coronavirus-panic-133739">surprise decision to cut interest rates</a> to near-zero. </p>
<p>Additionally, there’s something known as the <a href="https://www.sec.gov/dera/staff-papers/white-papers/10mar17moiseflahertyluld">“limit up, limit down” rule</a>, which set limits on how much any stock, exchange-traded fund or futures contract can go up or down in a five-minute period before triggering a temporary halt in trading for that security. This rule was created in reaction to the so-called <a href="https://www.reuters.com/article/us-flashcrash-europe/special-report-globally-the-flash-crash-is-no-flash-in-the-pan-idUSTRE69E1Q520101015">flash crash in May 2010</a> in which a single algorithmic trade led to a 1,000-point intraday drop in the Dow Jones Industrial Average – at the time worth approximately US$1 trillion in market value. </p>
<h2>2. Have these measures been triggered before?</h2>
<p>U.S. markets first began implementing circuit breakers in 1988 following the “Black Monday” crash on Oct. 19, 1987, <a href="https://www.reuters.com/article/us-usa-markets-1987-quotes/quote-box-recollections-of-the-1987-crash-idUSN1942062020071020">when the S&P 500 fell 22.6%</a>. The goal was <a href="http://doi.org/10.1257/jep.2.3.3">to reduce overall market volatility</a>.</p>
<p>The first and last time U.S. markets hit the circuit breaker – before this year – was <a href="https://www.sec.gov/news/studies/tradrep.htm">during the Asian financial crisis</a> on Oct. 27, 1997. This shows just how infrequent price changes of this magnitude are. Neither the dot-com crash of 2000 nor the 2008 financial meltdown triggered a circuit breaker. </p>
<h2>3. Do they work?</h2>
<p>It depends on what we mean by “work.” </p>
<p><a href="https://www.jstor.org/stable/2329072?seq=1">Their intended purpose</a> was to stop a deluge of traders selling assets at increasingly lower prices to get out before the market collapses entirely – and in effect contributing to that collapse.</p>
<p>This type of fear-driven run on the markets is dangerous: If no one is taking the buy position, <a href="https://doi.org/10.1111/j.1540-6261.1990.tb03719.x">it becomes a race to the bottom</a>. </p>
<p>Since circuit breaks are rare and we don’t have lots of events to go on, it’s hard to say how effective they are. But so far, every time they’ve been triggered, stocks have rebounded the following day. That’s <a href="https://money.cnn.com/1997/10/28/markets/marketwrap/">what happened</a> in October 1997, and when the breakers were triggered on <a href="https://www.cnbc.com/2020/03/10/what-happened-to-the-stock-market-tuesday-big-rally-on-fiscal-stimulus-hopes.html">March 9</a> and <a href="https://finance.yahoo.com/news/stock-market-news-live-updates-march-13-2020-115257012.html">March 12</a> of this year. </p>
<p>This suggests they were effective at ending panic selling – at least temporarily. They are not intended to prevent markets from continuing to go down. And research shows circuit breakers may actually <a href="https://www.doi.org/10.1111/j.1540-6261.1994.tb04425.x">increase market volatility in the days and weeks that follow</a>. This means that while prices rebound the day following a trading halt, markets experience larger swings in prices over a longer period, which is generally seen as a bad thing. </p>
<p>And just because the halts have led to rebounds in the past doesn’t mean they’ll keep doing so. </p>
<h2>4. So why not just shut down markets for a while?</h2>
<p>The president does have the power to shutter markets in response to a crisis such as the COVID-19 pandemic. </p>
<p>In fact, the markets <a href="https://www.motherjones.com/politics/2015/07/new-york-stock-exchange-shutdown-history/">have been closed many times</a> due to war, victory, deaths of presidents, the celebration of historical events of significance like the Moon landing and disasters, both natural or man-made. For example, the NYSE shut down for the week <a href="https://money.cnn.com/2001/09/11/markets/exchanges/">following the 9/11 terrorist attacks</a> and closed for two days during <a href="https://money.cnn.com/2012/10/28/investing/hurricane-sandy-stock-exchange/index.html">Hurricane Sandy in 2012.</a></p>
<p>The <a href="http://dx.doi.org/10.2139/ssrn.446406">longest shutdown on record</a> was during World War I, when the the NYSE closed for four months beginning in July 1914.</p>
<p>Normally, however, the market remains open as much as possible even during periods of financial crisis, and the management of each exchange is responsible for determining whether there will be trading that day or not. The government, however, has <a href="https://fas.org/sgp/crs/natsec/98-505.pdf">broad powers in regulating commerce</a> during national emergencies, which includes the ability to order a shutdown.</p>
<p>So should President Donald Trump order one? </p>
<p>There’s actually no research that I’m aware of on the efficacy of closing down stock markets during crises. But it’s important to understand that even when markets are crashing, investors usually prefer them to stay open so they can continue to trade. </p>
<p>Moreover, the U.S. holds a principal place in the financial world as a strong and active market for trading securities. If the market is closed too long, or for capricious reasons, it can give the signal that American markets are not free of government intervention and that they are unreliable. </p>
<p>While temporary halts to trading gives market participants time to parse information and make more levelheaded decisions, a shutdown could cause real damage to U.S. investments in the long run if they’re seen as less of a haven to global investors.</p>
<p>[<em>Insight, in your inbox each day.</em> <a href="https://theconversation.com/us/newsletters?utm_source=TCUS&utm_medium=inline-link&utm_campaign=newsletter-text&utm_content=insight">You can get it with The Conversation’s email newsletter</a>.]</p><img src="https://counter.theconversation.com/content/133671/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Jonathan T. Fluharty-Jaidee does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Plunging stocks have triggered rarely used ‘circuit breakers’ that temporarily halt trading. A finance scholar explains what they are and the costs of shutting down markets.Jonathan T. Fluharty-Jaidee, Assistant Department Chair and Professor of Finance, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1090492018-12-21T19:50:38Z2018-12-21T19:50:38ZStumped by the stock market slump? Start by picturing a used car dealership<figure><img src="https://images.theconversation.com/files/251903/original/file-20181221-103641-c2ll5c.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Trading stocks can be a lot like buying a used car.</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/classic-american-car-edsel-sale-displayed-359935604?src=pJ2u7HHB_BYqxooZTXbJDg-1-94">goory/Shutterstock.com</a></span></figcaption></figure><p><a href="https://www.cnn.com/2018/12/21/investing/bear-market-stocks-global/index.html">Stocks have been slumping</a> on a variety of concerns, from President Donald Trump’s <a href="https://theconversation.com/us/topics/trade-wars-50746">ongoing trade war</a> with China to worries about an <a href="https://theconversation.com/could-a-recession-be-just-around-the-corner-108372">economic slowdown</a> and <a href="https://theconversation.com/the-fed-cares-when-the-stock-market-freaks-out-but-only-when-it-turns-into-a-bear-109124">rising interest rates</a>. </p>
<p>Given the many factors driving shares up or down on any day or week, it’s hard to make sense of what’s happening on Wall Street. </p>
<p>Based on my many years of experience teaching and writing about <a href="https://www.jstor.org/stable/3487115?seq=1#page_scan_tab_contents">financial markets and frauds</a>, I believe the best way to understand what’s happening on Wall Street – and puncture its mystique – is to imagine it as a used car dealership. </p>
<h2>Stock markets 101</h2>
<p>Stock exchanges are places where people trade ownership in corporations by buying and selling shares. </p>
<p>Partial ownership of a company comes with benefits, such as a cut of future profits and rising stock prices. But there are risks and costs as well. Share price can fall, reducing the value of one’s wealth; even worse, businesses can go under, reducing the value of ownership to zero. </p>
<p><a href="https://www.financialsamurai.com/what-percent-of-americans-own-stocks/">About half the population</a> owns at least some stocks, mostly in their 401(k)s. But, except for the richest 10 percent of Americans, stock holdings are usually on the smaller side.</p>
<p>The New York Stock Exchange, one of several in the U.S., is the <a href="http://www.investopedia.com/terms/n/nyse.asp">largest securities exchange</a> in the world. At a <a href="https://www.stockmarketclock.com/exchanges/nyse">current market value of almost US$23 trillion</a>, it’s worth more than the GDP of the U.S. and the <a href="http://statisticstimes.com/economy/projected-world-gdp-ranking.php">world’s other big economies</a>. </p>
<p>Stock exchanges play an important economic role by helping companies finance new investments. When a large company wants to expand, it goes to an exchange like the NYSE and offers investors a stake in its business through what is known as an initial public offering. That’s exactly what ride-hailing services <a href="https://www.recode.net/2018/12/6/18128937/lyft-ipo-uber-strategy">Lyft and Uber plan to do</a> at some point in 2019. </p>
<h2>Selling used cars</h2>
<p>However, this is not what stock trading is mainly about. Virtually all the <a href="https://data.worldbank.org/indicator/CM.MKT.TRAD.CD">$80 trillion or so</a> in daily trading on the NYSE and other exchanges around the world involves someone who already owns shares of a company selling them to somebody else. In other words, it is very much like a used car dealership.</p>
<p>Used car dealers buy old automobiles and resell them. Similarly, stock markets are places where someone sells their ownership in a company to a dealer, who then finds someone else to buy it. That is it. Ownership of a company changes hands, with the exchange serving as the middleman. </p>
<p>These exchanges have benefits. They enable us sell things quickly. When I want to get rid of my car, it is more convenient to have a used car dealer serve as an intermediary than for me to sell it myself. Because it is easy to sell my car every few years, I may purchase a new one more frequently, which increases consumer spending and strengthens the economy. </p>
<h2>Selling lemons</h2>
<p>But there are also negatives to stock markets.</p>
<p>As used car buyers know, it is <a href="http://abcnews.go.com/GMA/story?id=126960&page=1">easy to end up with a lemon</a>. Most people don’t know the specifics of a particular used car. Its past and even its present condition is often a total mystery.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=422&fit=crop&dpr=1 600w, https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=422&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=422&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=530&fit=crop&dpr=1 754w, https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=530&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/251905/original/file-20181221-103634-1huxggy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=530&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Be wary of buying a lemon.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/freshly-squeezed-lemon-juice-small-bowl-211542739?src=5d2zIasWq9vUb68vqhZp9w-1-62">Joshua Resnick/Shutterstock.com</a></span>
</figcaption>
</figure>
<p>And car dealers <a href="https://www.theconsumerlawgroup.com/blog/five-examples-of-auto-dealer-fraud.cfm">have incentives</a> to hide flaws in what they’re selling – and thus deceive potential buyers. Revealing flaws in the car will likely lose them sales and commissions.</p>
<p>Similarly, investors typically don’t know much about a particular company. Such knowledge requires doing a lot of homework about the company – its past history, its senior executives and its future plans – as well as knowing how to read financial statements. This is much harder than homework on a specific car that you are thinking about buying. </p>
<p>And just as car dealers can make a lemon look good for a test drive, companies can <a href="https://www.investopedia.com/articles/analyst/071502.asp">cook their books</a> or drive up their stock price to make themselves look good. </p>
<p>Furthermore, the stock market can help turn companies into lemons. Wall Street’s focus on short-term stock price gains means that it <a href="https://theconversation.com/trump-presidencys-personnel-turmoil-stands-in-stark-contrast-to-the-nice-guy-administration-of-george-h-w-bush-108560">cares more</a> about what will generate a quick buck rather than what will support long-term growth and profitability. Consequently, companies end up focusing more on doing whatever drives up the value of its shares at the expense of producing quality products efficiently, worker training and customer satisfaction. </p>
<p>This is why we keep seeing business scandals such as <a href="https://theconversation.com/the-not-so-invisible-damage-from-vw-diesel-cheat-100-million-in-health-costs-48296">car companies like Volkswagen installing deceptive exhaust systems</a> and <a href="https://theconversation.com/how-wells-fargo-encouraged-employees-to-commit-fraud-66615">financial firms such as Wells Fargo</a> that charge customers for accounts that <a href="https://www.nytimes.com/2016/10/12/business/dealbook/at-wells-fargo-complaints-about-fraudulent-accounts-since-2005.html">they did not ask for</a>. </p>
<p>The history of financial markets is also a <a href="http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470601809.html">history of fraud</a>, from the <a href="https://www.library.hbs.edu/hc/ssb/history.html">South Sea Bubble</a> of the early 18th century to <a href="http://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7">Bernie Madoff’s Ponzi scheme</a> in the 2000s.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=530&fit=crop&dpr=1 600w, https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=530&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=530&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=666&fit=crop&dpr=1 754w, https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=666&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/251906/original/file-20181221-103641-1d3cdgo.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=666&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">In the old days, there used to be a lot more paper on the floor of the NYSE.</span>
<span class="attribution"><a class="source" href="http://www.apimages.com/metadata/Index/Watchf-AP-A-NEW-YORK-USA-APHS132962-New-York-St-/bde51a43a4694a2296be3d609f7b8a54/35/0">AP Photo</a></span>
</figcaption>
</figure>
<h2>Making sense of the slump</h2>
<p>So what does this all mean for the current market slump? </p>
<p>One important lesson is that Wall Street is not the economy. If stocks go up or down, this doesn’t mean that the economy has necessarily improved or worsened. It only means that “pieces of paper” being bought and sold have changed in value. Some people get richer, others poorer. </p>
<p>However, sharp stock market declines can have a real world impact, such as when a “bubble” collapses. That’s what happened in 2008 and what happened in October 1929, when a <a href="https://www.history.com/topics/great-depression/1929-stock-market-crash">stock market crash</a> caused by a bursting bubble led to an 80 percent drop in stock prices. That market swoon helped spawn the Great Depression, which saw an average of 15 percent unemployment for an entire decade, soup lines throughout the country and a 30 percent decline in economic activity and average incomes.</p>
<p>In other words, <a href="https://www.independent.co.uk/news/business/analysis-and-features/history-lessons-galbraiths-the-great-crash-1929-is-still-essential-reading-today-956710.html">when bubbles burst</a>, the economic damage can be substantial. People become poorer and spend less. Corporate profits plummet, causing stocks to fall even further. People become skeptical of the stock market and won’t lend money to firms that want to expand their operations. A downward spiral can quickly deepen and become self-reinforcing. </p>
<p>The bottom line: While you shouldn’t panic about Wall Street’s current woes, there are still reasons to pay attention to the economy and stock market. And, most important of all, if you’re an investor, do your homework and steer clear of lemons. </p>
<p><em>This is an updated version of an <a href="https://theconversation.com/why-wall-street-is-like-a-used-car-lot-73570">article originally published</a> on March 5, 2017.</em></p><img src="https://counter.theconversation.com/content/109049/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steven Pressman does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Stock markets have plunged in recent months on concerns over Trump’s trade war and the possibility of a recession. An economist explains how stocks are like used cars – and lemons.Steven Pressman, Professor of Economics, Colorado State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/913162018-02-06T04:58:25Z2018-02-06T04:58:25ZASX and Wall Street fall: investors should start to worry when volatility seems low<p>Rewind to last week and the volatility index, or VIX, actually predicted low levels of volatility in the share market over the coming 30 days. But the subsequent falls in the Australian and United States share markets should serve as a reminder of the risk of being complacent.</p>
<p>Prolonged periods of low volatility provide ample opportunity for investors to become complacent about risk, and increase the prospect of sharp market corrections. This is certainly what <a href="http://www.tandfonline.com/doi/abs/10.1080/00036846.2016.1167830">my research has discovered</a>. I found buying stocks when investor fear is highest, and selling when it is lowest, can be a profitable trading strategy. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/explainer-why-stock-market-panic-can-signal-a-good-time-to-buy-56349">Explainer: why stock market panic can signal a good time to buy</a>
</strong>
</em>
</p>
<hr>
<p>Now the US S&P 500 index has fallen by over 6% since Thursday (wiping over US$1 trillion from stock values), the VIX index has more than doubled and now sits at 37.32. While this is the highest level since August 2015, it’s still well below the high of 80.06 we saw during the global financial crisis.</p>
<p>The trigger for this surge in investor fear in the US was Friday’s release of employment data there. Typically, this <a href="https://www.bloomberg.com/news/articles/2018-02-02/u-s-added-200-000-jobs-in-january-wages-rise-most-since-2009">stronger than expected data</a> would be good for stocks. However, this news follows indications from the Federal Reserve that <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20180131a.htm">further rate hikes are likely</a>.</p>
<p>The market has taken strong wage growth as a signal of inflationary pressure, which may lead to more dramatic policy tightening. This is consistent with <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2005.00742.x/full">prior research</a> that suggests the market response to economic news depends on the business cycle. </p>
<p>Unfortunately, owing to reliance on exports to fuel its economy, the Australian market is not immune to what happens in the US. The All-Ordinaries has fallen by 4% (equivalent to nearly A$90 billion of value) and the A-XVI (an Australian fear gauge) has jumped by 60% in two sessions.</p>
<h2>Due for a correction</h2>
<p>As of the end of January, the US S&P 500 were 320% higher than at the peak of the 2008 financial crisis, having increased 25% in the past year. While the Australian market has lagged, following the end of the commodity boom, the All-Ordinaries is still 98% higher than in 2008 and 8% higher than at this time last year. </p>
<p>Over the same time, the VIX index has been able to shrug off the affects of a rising geopolitical risk – such as President Trump’s tiff with North Korea. </p>
<p>Over the past year, VIX has averaged just 11.06. This <a href="https://papers.ssrn.com/sol3/Papers.cfm?abstract_id=1296743">indicates</a> that in the next 30 days the market expects prices to rise or fall by 6.3% (on approximately 95 days out of 100). This is lower than the average of 14.9 for the prior year, and 18.8 over the past 15 years. </p>
<p><iframe id="qsGbk" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/qsGbk/1/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p>While the VIX has continued to predict low levels of volatility in the near-term (it ended Thursday at 13.47), <a href="http://libertystreeteconomics.newyorkfed.org/2017/11/the-low-volatility-puzzle-is-this-time-different.html">researchers at the New York Federal Reserve</a> pointed out that the term structure of implied volatility suggested volatility will not remain low forever. The term structure shows how implied volatility varies for different time periods, and prior to Thursday this was upward sloping - indicating volatility would rise over time. </p>
<p>It’s difficult to predict when the current market sell-off will end, and after the large increase in values over the past few years it could be said that the market is due a correction. While the futures market is predicting further falls in stock prices (and VIX increases) in the near-term, the term structure (which is now downward sloping) is not predicting a lengthy period of volatility.</p>
<p>One risk could be that ongoing gridlock within US Congress leads to another US government shutdown, and associated geopolitical risk finally starts to feed into investor fear. </p>
<p>The lesson remains: investors should be wary when investor fear is low.</p><img src="https://counter.theconversation.com/content/91316/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Smales does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Volatility indexes show that investors have been complacent about the risk of a share market correction.Lee Smales, Associate Professor, Finance, Curtin Graduate School of Business, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/807822017-07-28T16:34:23Z2017-07-28T16:34:23ZWhy crowds aren’t always wise: Lessons from mini-flash crashes on Wall Street<p>Blink. About <a href="http://bionumbers.hms.harvard.edu/bionumber.aspx?&id=100706&ver=4">300 milliseconds</a> just passed, the same time required for a lightning bolt to <a href="http://www.maine.gov/mema/prepare/prep_display.shtml?163524">travel 100,000 feet</a>, a satellite to <a href="http://howthingsfly.si.edu/ask-an-explainer/do-all-satellites-have-fly-same-speed-so-not-leave-their-orbit">fly two miles</a> or a stock price to swing <a href="http://www.nanex.net/aqck2/4178.html">from US$10 to $0.0001 and back</a>.</p>
<p>Wait, what?</p>
<p>Indeed, that actually happened to the shares of the software company Qualys a few years ago. Similar mini-flash crashes involving substantial, instantaneous price moves take place about <a href="http://money.cnn.com/2013/03/20/investing/mini-flash-crash/index.html">12 times a day</a>. </p>
<p>Remember the flash crash back in 2010, when hundreds of stocks <a href="https://www.sec.gov/news/studies/2010/marketevents-report.pdf">temporarily went bonkers</a> and the Dow Jones Industrial Average dove 1,000 points in a few minutes? Mini-flash crashes are the same thing yet on a smaller scale, with perhaps only one company’s shares <a href="https://arxiv.org/abs/1211.6667">going haywire</a> for a fraction of a second.</p>
<p>But they’re just as consequential, both for the individual stock and in the aggregate. Such bizarre events seem to contradict our basic beliefs about the fairness of values, the sophistication of modern markets and the oft-cited <a href="http://www.penguinrandomhouse.com/books/175380/the-wisdom-of-crowds-by-james-surowiecki/9780385721707/">wisdom of the crowd</a>. What’s going on?</p>
<p>To find out, we developed a <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2975769">mathematical model</a> to explore how all of these ideas fit together. We initially presumed that as long as there were lots of sharp investors with broad-ranging market views, mini-flash crashes would be fairly uncommon.</p>
<p>Surprisingly, we observed a “too many cooks spoil the broth”-type effect instead. Even the wisest crowd, if it’s large enough, can rapidly devolve into a mad herd and bring on these wild events.</p>
<h2>Mini-flash crashes in a nutshell</h2>
<p>Over <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3769652/">20,000 mini-flash crashes</a> have been recorded since 2006, the year they really took off. Some were bigger than others, but many were <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3769652/">pretty severe</a>.</p>
<p>They’re momentary, but if you get caught in one, you might incur substantial <a href="https://www.ft.com/content/fe944768-7124-11da-836e-0000779e2340">trading losses</a>, <a href="https://www.ft.com/content/4089c7d0-bba4-11e6-8b45-b8b81dd5d080">reputational damage</a>, <a href="https://www.wsj.com/articles/merrill-lynch-to-pay-12-5-million-fine-for-mini-flash-crashes-1474906677">fines</a> and <a href="https://www.bloomberg.com/news/articles/2016-11-09/accused-flash-crash-trader-sarao-to-plead-guilty-in-chicago">legal woes</a>.</p>
<p>More broadly, they may <a href="https://www.sec.gov/news/pressrelease/2016-192.html">erode investors’ trust in markets</a>, violate <a href="http://www.bloomsbury.com/us/forecast-9781608198535/">Nobel Prize-winning theories</a> and even escalate into <a href="http://www.nytimes.com/2010/10/02/business/02flash.html">full-blown flash crashes</a> like the big one from 2010. In fact, that infamous flash crash began as a disruption in a <a href="http://www.nytimes.com/2010/10/02/business/02flash.html">single instrument</a>, the E-Mini S&P 500 futures contract.</p>
<p>Sounds pretty serious, huh?</p>
<p>Regulators agree and have <a href="https://www.sec.gov/rules/sro/nms/2012/34-67091.pdf">installed measures</a> in hopes of managing them. One rule wipes out trades that are <a href="https://www.nyse.com/publicdocs/nyse/markets/nyse-arca/NYSE%20Arca%20Rule%207.10.pdf">obviously wrong</a> (probably no one means to sell stock for hundredths of a penny). Another rule acts like a <a href="https://www.sec.gov/rules/sro/nms/2012/34-67091.pdf">circuit breaker</a> in your home, temporarily freezing markets when prices overheat.</p>
<p>Traders pitch in as well. For example, have you ever heard of a <a href="http://www.bbc.com/news/business-29454265">fat finger error</a>? Maybe you wanted to sell one share at $100 but accidentally unloaded 100 shares at $1 because of a mistaken keystroke or two. Bang, the stock plunges 99 percent instantly. Financial firms maintain <a href="https://www.sec.gov/news/pressrelease/2016-192.html">internal checks</a> such as operational risk controls to avoid such havoc.</p>
<p>Yet, despite all this, mini-flash crashes keep <a href="http://www.cnbc.com/2017/06/22/buyers-beware-lessons-from-the-ethereum-flash-crash.html">happening</a>, and some worry the problem is getting <a href="https://www.bloomberg.com/news/articles/2017-06-26/gold-plunges-as-1-8-million-ounces-traded-in-a-new-york-minute">worse</a>.</p>
<h2>An army of simulated investors</h2>
<p>To understand why the mini-flash crash problem just won’t go away, we designed a model that takes <a href="http://www.wiley.com/WileyCDA/Section/id-400799.html">all we know about investing</a> and subjected it to mathematical analysis and computer simulations so we could observe whether a group of traders armed with various strategies could steer clear of mini-flash crashes. </p>
<p>For instance, in developing our model, we wanted to ensure that our “investors” devised their strategies as if they were actually human. In addition to classic questions like “Where are prices going?,” today’s traders ponder much more sophisticated issues before buying or selling. They might ask, “How confident am I in this answer? How often should I check back to make sure it’s still right? Am I worried about betting the bank? Could my trades themselves impact the future and change whether I’m ultimately right?”</p>
<p>We plugged these considerations into mathematical formulas. Each of our investors was assigned specific parameters (like the models Wall Street traders use), which served as guides for how and when they would trade given various market conditions. </p>
<p></p><hr><p></p>
<p><iframe id="Uzge8" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/Uzge8/2/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p></p><hr><p></p>
<p>In other words, we tried to make our simulated investors as complicated as real ones, with a healthy mix of characteristics.</p>
<p>Here’s what we found. </p>
<p>Our investors initially operated a calm and stable market, free of crashes. The supposed wisdom of the crowd prevailed, as long as certain conditions held true:</p>
<ol>
<li><p>All investors were confident in their opinions about future markets.</p></li>
<li><p>All investors fully reworked their models often. That is, models (like the ones described above) can become corrupted over time and need to be readjusted. A failure of investors to readjust their models likely contributed to the <a href="http://time.com/3741681/2000-dotcom-stock-bust/">dot-com bubble</a> or the <a href="https://www.forbes.com/2008/12/31/housing-bubble-crash-oped-cx_bb_0102bartlett.html">housing bubble</a>, when we watched prices go up and up and figured that the good times would last forever. If only we’d taken a step back to check ourselves, right? </p></li>
<li><p>All investors were hesitant to take big risks. </p></li>
<li><p>There weren’t too many investors. It’s not that we found a specific number here; rather we discovered that the crowd sometimes got so large that the extra stability provided by their varied opinions got outweighed by their tendency to stampede towards a mini-flash crash at the slightest tremor. </p></li>
</ol>
<p>But in a fast-moving market, these conditions didn’t always persevere. Even though investors were continually revising their views, they weren’t doing so fast enough to avoid being caught up in a herd mentality and selling off a stock along with everyone else in response to a lone investor’s opinion. </p>
<p></p><hr><p></p>
<p><iframe id="ABlMT" class="tc-infographic-datawrapper" src="https://datawrapper.dwcdn.net/ABlMT/3/" height="400px" width="100%" style="border: none" frameborder="0"></iframe></p>
<p></p><hr><p></p>
<p>Say some investor got spooked and started selling. This drove prices down a little, which may have worried a few others. They started selling too, causing prices to drop even further. Pretty soon, the whole market was unloading, and prices hit rock bottom. </p>
<p>If our investors weren’t sure about their views, this all happened much faster. They’d change their beliefs on a dime. We saw the same thing when they weren’t afraid of taking risks or didn’t step back enough to reassess their strategies.</p>
<p>What was most surprising for us, as previous believers in the strength of wise crowds, was that increased population size alone could be destabilizing. In fact, the number of investors active in our simulations was one of the greatest determinants of whether a mini-flash crash would ensue.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=383&fit=crop&dpr=1 600w, https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=383&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=383&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=482&fit=crop&dpr=1 754w, https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=482&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/179646/original/file-20170725-30134-6wzeq5.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=482&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">‘Tulipmania’ in the 17th century is often considered the first market bubble. Here, monkeys portray Dutch speculators buying and selling rare tulip bulbs.</span>
<span class="attribution"><a class="source" href="https://commons.wikimedia.org/wiki/File:Jan_Brueghel_the_Younger,_Satire_on_Tulip_Mania,_c._1640.jpg">Brueghel the Younger</a></span>
</figcaption>
</figure>
<h2>History repeats</h2>
<p>Our research suggests it may be impossible to completely stop mini-flash crashes, as recent high-profile plunges in the prices of <a href="https://www.bloomberg.com/news/articles/2017-06-26/gold-plunges-as-1-8-million-ounces-traded-in-a-new-york-minute">gold</a> and <a href="http://www.cnbc.com/2017/07/07/silver-plunges-in-yet-another-mysterious-market-flash-crash.html">silver</a> demonstrate. Many market observers claim that such instantaneous tumbles are the “<a href="https://blogs.cfainstitute.org/marketintegrity/2015/07/24/sleepless-in-seattle-is-living-with-threat-of-market-flash-crashes-the-new-normal/">new normal</a>.”</p>
<p>Perhaps it’s not so startling. After all, back in 1841, Scottish journalist Charles Mackay had already brought the recurring nature of bubbles and crashes to the public’s attention in “<a href="https://www.gutenberg.org/files/24518/24518-h/dvi.html">Memoirs of Extraordinary Popular Delusions and the Madness of Crowds</a>.” To some extent, it’s no wonder that they should be frequent and rapid these days, given the speed of <a href="https://www.bloomberg.com/news/articles/2014-07-24/high-frequency-traders-find-microwaves-suit-their-need-for-speed">today’s markets</a>.</p>
<p>That tulip trading persisted late into the night at Dutch taverns (after many rounds) has been cited as a <a href="https://mitpress.mit.edu/books/famous-first-bubbles">potential cause of “Tulipmania</a>,” an event in the 1600s where a single bulb is rumored to have cost as much as <a href="https://www.gutenberg.org/files/24518/24518-h/dvi.html">50 live pigs</a>. While we’re a long way from such things, the line between a wise crowd offering stability and a mad one creating chaos is clearly as thin as ever.</p><img src="https://counter.theconversation.com/content/80782/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexander Munk receives funding from a University of Michigan Rackham Predoctoral Fellowship. </span></em></p><p class="fine-print"><em><span>Erhan Bayraktar receives funding from the National Science Foundation. </span></em></p>New research suggests mini-crashes, in which the price of a single stock or commodity temporarily goes haywire, may be unstoppable.Alexander Munk, Ph.D. Candidate in Mathematics, University of MichiganErhan Bayraktar, Professor of Mathematics, University of MichiganLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/735702017-03-06T02:15:36Z2017-03-06T02:15:36ZWhy Wall Street is like a used car lot<p>In 1792, before there was the internet, the telephone or even the telegraph, securities trading began on Wall Street. </p>
<p>A small group of dealers, <a href="http://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1790/1792_0517_NYSEButtonwood.pdf">who met under a buttonwood tree on Wall Street</a>, agreed to trade only with each other and established a minimum fee for their service. At that time, most trading involved the buying and selling of government bonds.</p>
<p>A quarter-century later, on March 8, 1817, securities dealers changed their rules a bit, moved into bigger quarters on Wall Street and officially created the New York Stock and Exchange Board. This was later shortened to the New York Stock Exchange (NYSE). Today it is the <a href="http://www.investopedia.com/terms/n/nyse.asp">largest securities exchange</a> in the world, trading around <a href="http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=table&key=3140&category=3">US$200 billion</a> each day, mainly stock certificates or ownership shares in private firms. The value of all the companies on the NYSE, about $16 trillion, comes close to the value of what the U.S. economy produces in new goods and services each year.</p>
<p>As the NYSE marks this bicentennial milestone, it is worth asking, what do stock markets actually do? </p>
<p>This question is particularly apt right now as U.S. shares set new records on a regular basis, with <a href="https://www.theatlantic.com/business/archive/2017/01/trump-bump/513698/">some</a> calling the roughly 15 percent gain in the Standard & Poor’s 500 since Election Day a “Trump bump” created by optimism about his plans, while others chalk it up to “irrational exuberance,” to use a famous phrase of Alan Greenspan, former chair of the Federal Reserve. </p>
<p>Based on my many years of experience teaching and writing about <a href="https://www.jstor.org/stable/3487115?seq=1#page_scan_tab_contents">financial markets and frauds</a>, the best way to understand what’s really happening on Wall Street – and puncture its mystique – is to imagine a used car dealership. </p>
<h2>The aura of the NYSE</h2>
<p>The NYSE gets its aura from the fact that so much money is involved. Even for those with a relatively small stock portfolio, a change in stock prices of 2 to 3 percent can result in gains or losses amounting to thousands of dollars. </p>
<p>Also, people are attracted by simple numbers, especially ones that fluctuate and get reported regularly with much fanfare, such as <a href="http://articles.mcall.com/2005-09-11/news/3616708_1_gasoline-prices-gas-prices-price-surge">gasoline</a> and stock prices.</p>
<p>More importantly, the NYSE helps finance new investment. When a large company wants to expand, it prints up new shares of stock and then tries to sell them. If successful, the company gets money (fresh capital) that enables it to expand its operations. This is what Snap Inc. – maker of the Snapchat app – <a href="http://www.reuters.com/article/us-snap-ipo-idUSKBN1690I7">did on March 2</a>, when it raised $3.4 billion in its initial public offering. </p>
<p>However, this is not what most stock trading is about. Virtually all the activity on the NYSE involves someone who already owns part of a company (represented by stock certificates) selling it to somebody else. </p>
<p>In this way it is very much like a used car dealership. Used car dealers buy old cars and resell them. Similarly, stock markets are places where someone sells her part ownership in a company to a dealer, who then finds someone else to buy it. </p>
<p>That is it. Ownership of a company changes hands, with the exchange serving as the middleman or used car dealer. Other than at the dealership, which makes some money on the trade, no jobs get created and no production takes place. </p>
<h2>Of liquidity and lemons</h2>
<p>From this perspective, stock exchanges like the NYSE have some positives as well as some negatives. </p>
<p>On the positive side, markets let us sell things quickly. When I want to get rid of my car, it is more convenient to have a used car dealer serve as an intermediary than for me to sell it myself. In addition, because it is easy to sell my car every few years, I may purchase a new car more frequently, which increases consumer spending and strengthens the economy. Similarly, it is easier for companies to raise money for new investment when the buyer knows he can resell the shares easily. In Wall Street parlance, this is called “liquidity.” </p>
<p>But there are also negatives. First, as all used car buyers know, it is <a href="http://abcnews.go.com/GMA/story?id=126960&page=1">easy to end up with a lemon</a>. Most people don’t know the specifics of a particular car or a specific company. In both cases, there are incentives for sellers – the car dealers or investment advisers – to hide any flaws in what they want to sell, thereby deceiving buyers. Commissions for making sales is more important for these people than helping a buyer make a good decision. </p>
<p>The history of financial markets is also a <a href="http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470601809.html">history of fraud</a>, from the <a href="https://www.library.hbs.edu/hc/ssb/history.html">South Sea Bubble</a> of the early 18th century to <a href="http://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7">Bernie Madoff’s Ponzi scheme</a> in the 2000s. </p>
<p>Second, financial markets (unlike used car markets) tend to generate speculative excess since people buy assets to make financial gains rather than consume what they buy. <a href="http://www.nytimes.com/2011/09/04/business/economy/on-wall-st-a-keynesian-beauty-contest.html">Economist John Maynard Keynes compared</a> stock markets with a rather strange beauty contest whose objective was to pick (from a large group of faces) not the most beautiful one, but the one that others would pick as the most beautiful. </p>
<p>Keynes got it exactly right. On stock exchanges, success means doing what other people are doing, rather than buying the shares of companies that are really the best. Such herd optimism can last only so long, however. The stock market crash of October 1929 saw the Dow Jones Industrial Average fall 25 percent in two days, followed by further sharp declines. By May 1932, the market had lost 80 percent of its peak value. The Great Depression that followed <a href="https://www.amazon.com/Great-Crash-1929-Kenneth-Galbraith/dp/0547248164">showed that when bubbles burst</a>, the damage to the economy can be very long and very large. </p>
<p>Similarly, the 2008-2009 stock market plunge of more than 40 percent resulted in the Great Recession.</p>
<p>Finally, because people pay attention to readily available numbers and are attracted to wealth, rising stock prices become more important than producing a quality product efficiently. Owners of company stock care about recent performance and the quarterly results (sales and profits) of individual firms. They care less about the long-term investment plans of the business and whether quality is improving (something that leads to reputational gains and more profits in the future). As a result, company CEOs come to care more about the short-run performance of the firm and less about the long-term performance. </p>
<p>This is why we constantly get scandals such as <a href="https://theconversation.com/the-not-so-invisible-damage-from-vw-diesel-cheat-100-million-in-health-costs-48296">car companies installing exhaust systems</a> that are polluting but can beat inspection tests and <a href="https://theconversation.com/how-wells-fargo-encouraged-employees-to-commit-fraud-66615">financial firms</a> that sign customers up for accounts that <a href="https://www.nytimes.com/2016/10/12/business/dealbook/at-wells-fargo-complaints-about-fraudulent-accounts-since-2005.html">they did not ask for</a> and then charging them for this.</p>
<p>Quarterly financial results will look good and keep Wall Street happy. But unhappy customers will eventually abandon the business, leading to falling profits. </p>
<h2>Unraveling the ‘Trump bump’</h2>
<p>This brings us back to the so-called Trump bump. </p>
<p>Investors <a href="https://www.federalreserve.gov/econresdata/notes/feds-notes/2014/some-implications-of-knightian-uncertainty-for-finance-and-regulation-20140410.html">dislike uncertainty</a>. Upcoming elections add uncertainty, which ends with the election results no matter the outcome. This is one reason <a href="https://theconversation.com/will-the-trump-rally-continue-through-2017-70776">stocks tend to perform well</a> in the year after a presidential election.</p>
<p><a href="http://www.1stock1.com/1stock1_141.htm">Stock prices rose</a> 23 percent and 30 percent, respectively, in each of the years after Barack Obama won the election. They increased 7 percent and 31 percent following Bill Clinton’s victories in 1992 and 1996. </p>
<p>Economic factors are not irrelevant, though. Stocks did poorly the year after Ronald Reagan’s first election due to economic circumstances (ditto for George W. Bush) but rose 26 percent the year after “The Gipper” was reelected in 1984. </p>
<p>While we are likely to see a similar post-election rise in stock prices this year thanks to reduced uncertainty, there are other factors behind the recent rally. <a href="https://www.theatlantic.com/business/archive/2017/01/trump-corporate-tax-cut/514148">President Trump has promised</a> deregulation and corporate tax cuts, which will increase corporate profits and make their shares more valuable. </p>
<p>But his post-election honeymoon may not last long. One reason is that these policies could reduce middle-class incomes by limiting competition, reducing government spending and making another financial crisis more likely. And that’s bad news for companies, their stocks and the economy because consumers won’t be able to afford as many of their goods and services. </p>
<p>So just as the stock market feeds off optimism, when reality falls short of expectations, despair can create a downward spiral. The danger we face is that this “Trump bump” could be followed by a “Trump dump” if investors realize they’ve purchased a portfolio full of lemons.</p><img src="https://counter.theconversation.com/content/73570/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steven Pressman does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>As the New York Stock Exchange marks 200 years since its official formation, investors are wondering whether the surging stock market is a ‘Trump bump’ or more like a lemon.Steven Pressman, Professor of Economics, Colorado State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/181822013-09-16T03:01:25Z2013-09-16T03:01:25ZTwitter’s IPO: what we know so far<figure><img src="https://images.theconversation.com/files/31281/original/ftrszfdp-1379042894.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Twitter CEO, Dick Costolo, faces the challenge of adding value to the company's shares, without detracting from the user experience</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>In a tweet that could represent US$110 million for every one of its 135 characters, Twitter last week <a href="http://www.forbes.com/sites/tomiogeron/2013/09/12/twitter-files-for-ipo-confidentially/">announced</a> that it would be following fellow social network providers Facebook and LinkedIn in becoming a publicly listed company. Taking advantage of a <a href="http://www.forbes.com/sites/nathanvardi/2013/09/13/why-twitters-ipo-wont-be-like-facebooks-ipo/?utm_source=followingimmediate&utm_medium=email&utm_campaign=20130913">change</a> in federal regulations, Twitter has been able to keep its initial filing secret, leaving commentators the task of guessing details of company earnings, where it is going to file, what it is planning to do with the money it raises, and even which stock exchange it will list on. Here is what we think we know so far:</p>
<h2>Where it will list</h2>
<p>Consensus around the Twitter float appears to be that it will try to <a href="http://www.theguardian.com/business/2013/jul/31/facebook-shares-soar-advertising-revenue-mobile">avoid the mistakes made by Facebook</a> when it listed in 2012. Facebook did not sustain its initial share price valuation of $38 for very long after it went public and early investors bailed before the share price plummeted, dropping <a href="https://www.google.com/finance?cid=296878244325128">as low</a> as $18 three months later. It took over a year for its share price to go back over the offer price.</p>
<p>Facebook’s poor IPO was exacerbated <a href="http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171575032#.UjVhxWRgb6Y">by problems</a> on the NASDAQ exchange, which caused a delay in executing orders. Twitter is <a href="http://investorplace.com/ipo-playbook/3-reasons-the-twitter-ipo-will-list-on-the-nyse/">instead thought to be listing</a> on the New York Stock Exchange and avoiding using the same lead broker as Facebook, opting for Goldman Sachs as opposed to Morgan Stanley. The choice of the NYSE instead of the NASDAQ may also reflect the fact that, like LinkedIn, Twitter has much more appeal amongst business users than Facebook does.</p>
<h2>How much will it be for?</h2>
<p>When it comes to valuation of the float, <a href="http://www.theguardian.com/technology/2013/sep/13/twitter-ipo-shares-stock-market">estimates</a> have put Twitter’s possible market capitalisation at between $10 and $15 billion. This is based on an estimate of possible earnings of around $500 - $600 million. This of course has raised the question of how Twitter makes money and how much more money it can be expected to make. In this regard, Twitter can thank Facebook for <a href="http://www.theguardian.com/business/2013/jul/31/facebook-shares-soar-advertising-revenue-mobile">convincing investors</a> that it can crack the problem of making money out of mobile. Twitter’s service has always been heavily used on mobile platforms and so the question of whether it can succeed on this platform is moot.</p>
<h2>How will Twitter grow revenue after the IPO?</h2>
<p>Most of the money Twitter makes is <a href="http://www.huffingtonpost.com/2013/09/12/twitter-public-money_n_3916996.html">through advertising,</a> offering users and companies the ability to buy promoted tweets, promoted trends, verified accounts and other services that get them followers and attention. Post IPO we can expect more of the same, although Twitter’s recent purchase of advertising sales platform MoPub will allow them to offer real-time bidding for advertising on Twitter.</p>
<p>Some users had reported receiving promoted tweets through push notifications, which if true, would have signalled a marked escalation in Twitter’s aggressiveness in advertising. However, Twitter CEO Dick Costolo <a href="http://marketingland.com/twitters-dick-costolo-we-dont-send-ads-via-push-notification-58915">later</a> confirmed that Twitter didn’t send ads this way and it must have been the result of a software bug. Here Twitter has to be cautious, as an increase in advertising could end up detracting from the service they offer, and potentially cost Twitter users and popularity.</p>
<p>The IPO will give Twitter access to money it can use to fuel growth through acquisitions, but which direction it will take in doing this is not clear. All of the social networks are vying to become the main medium for sharing anything between people: observations, thoughts, activities and emotions. In addition to providing direct news, Twitter has effectively become a back-channel for live TV to integrate audience reactions and opinions into any event. Through its #music service, it provides a real-time feed of what music everyone is listening to, discovering or forgetting. This then helps the discovery and promotion of new music, something artists and music companies would certainly pay for. It is easy to see how this could be extended to film and other forms of entertainment.</p>
<p>Twitter also makes money from selling access to its data through its programming interface and this will continue to be an important part of its value. Twitter data can reveal enormous amounts of valuable information to any organisation that wants to tap into a real-time view of the public’s and more specifically, their customers’ actions, thoughts and views. For example, <a href="http://www.youtube.com/watch?v=w_j0VuJ-J9k">researchers</a> at the University of Rochester are tracking influenza through Twitter.</p>
<h2>Who benefits from the IPO?</h2>
<p>In many ways, an IPO is a way for investors, owners and key employees to realise a financial bonus from their investments and efforts. The <a href="http://www.theguardian.com/technology/2013/sep/13/twitter-ipo-shares-stock-market">beneficiaries</a> here will be the founders Jack Dorsey, Biz Stone and Evan Williams and a range of investors including current CEO Dick Costolo, Marc Andreesen and Amazon’s Jeff Bezos. Of course, the public can also now benefit by buying shares in Twitter and hope that they follow the example of social network LinkedIn whose share price has climbed from $35 at its IPO to its <a href="http://investors.linkedin.com/stockquote.cfm">current value</a> of $250.</p>
<h2>Final thoughts</h2>
<p>It is hard to believe that new companies can continue to grow revenue through what is <a href="http://www.nielsen.com/us/en/reports/2013/global-adview-pulse-lite---q1-2013.html">globally</a> a finite advertising spend. Advertising may continue to shift from analogue media to digital, favouring companies like Google, Facebook and Twitter, but ultimately this will be an increasingly hard market to show aggressive growth in.</p>
<p>For Twitter, the challenge will be to provide services that add monetary value, but are not seen as detracting from the experience of its users.</p><img src="https://counter.theconversation.com/content/18182/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Glance does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In a tweet that could represent US$110 million for every one of its 135 characters, Twitter last week announced that it would be following fellow social network providers Facebook and LinkedIn in becoming…David Glance, Director, Centre for Software Practice, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.