The Markets are Broken

Posted: Sep 09, 2011 12:01 AM

Technicians I know are talking about broken markets. The volatility is amazing and frightening at the same time.

As regular readers of this blog know, I don’t put much long term stock into technical analysis. However, I do like it for short term rule of thumb trading. It’s a tool, not a religion.

The unprecedented volatility in the markets can be explained by a couple of things, none of which have anything to do with technical analysis.

First, the world financial system hasn’t fully recovered from the shock of 2008. One of the reasons was the fiscal policy, and central bank response to the crisis. The policies prolonged it. We still haven’t taken our medicine yet.

Combine poor policy with total uncertainty to what type of regulation is coming and you have frozen decision making processes at every level of business.

Second, the rise of electronic trading and fragmented SEC regulated markets has contributed to volatility. There is more volume, but it is being traded by fewer and fewer players. Eventually the market will be a giant circle jerk.

A brief spate of roiling markets brings opportunity. Like a brush fire through a prairie, it’s a healthy event and brings new growth and perspective.

An hyper extended period of movement like we have observed over the past four years brings even more uncertainty. Instead of putting money to work, confident it will grow, people are looking for alternatives like metal. ($GLD, $GC_F, $SLV, $SI_F)

The average Joe sees the roller coaster movement of the market and holds back. They also cut back on their spending because they know that they are going to have to grow their household wealth via cash, not debt or equity.

The professional pension fund is also seeking safe havens. Instead of going full force into the market that they don’t trust, they plow money into US Treasuries that return almost nothing.

We do have a broken market structure. The effects of it are far reaching. The break down in structure isn’t because of electronic trading, it’s a total failure of the SEC.

The revolving door of DC and Wall Street keep the markets safe for bankers, and dangerous for the general public. The general public includes pension funds and corporations too. Instead of being customers, they are looked at as personal pigeons.

Fix the market structure. The volatility will subside.

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