crashing day traders

J. Barkley Rosser, Jr. rosserjb at
Thu Feb 25 14:10:27 PST 1999

This is a followup to my response to Henry Liu, given that he and I have had some offlist discussion of this matter and he is quota limited for the day as I shall be after this message,

I think that we need to distinguish between what the typical day trader does and what a sophisticated hedge fund trader does. Henry described what the latter do, "smoothing out market irrationalities." I'm not sure I would describe them as "irrationalities" so much as temporary divergences from equilibrium. Although such hedge fund traders tend to do it in a much fancier and more complicated way, often what they are doing is essentially a form of advanced arbitrage, buying in one market to sell at a higher price in another market. Such action makes the successful arbitrageur money and also tends to bring about the convergence of prices in the two markets that the "law of one price" tells us should hold in equilibrium.

However, this is very far from what the typical day trader is doing. First of all these folks are rarely doing any kind of hedging or arbitrage strategies. They are not shorting backflip straddles on the yen-euro long rate spread, or whatever. Most of them are engaged in the crudest sort of chartist trend chasing, buying some stock (uncovered) that starts to move upward and then jumping quickly out of it soon thereafter. A lot of money can be made doing that in a sharply rising market and such behavior can stimulate it further in a self-fulfilling prophetic manner. It is, however, also classic manic bubble speculation and thus open to sharp declines and panics. Money can be lost also. This kind of behavior does not stabilize or smooth over or achieve equilibrium or anything else noteworthy or socially useful in any way shape or form whatsoever. Barkley Rosser

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