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Comment by gxti | Hacker News Reader

Another reason that computerized trading (and speculative trading as well) is theoretically good for the market is that it makes prices more informative. If a trader or computer can successfully predict how a price will move based only on past and present information, then there is an inherent market inefficiency -- the market price is supposed to already reflect all of that information, and only moves when new information becomes available. Of course in reality information does not spread that readily and traders are not completely accurate at estimating prices, so correcting those inaccuracies is quite profitable and helps the market. By selling when a stock is overvalued and buying when it is undervalued, regardless of how that determination was made, the price becomes closer to the fundamental value and thus allows long-term investors to buy and sell at a fair price.

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I think this is a really important point. Reacting to new information nearly instantaneously improves the efficiency of the market by factoring in all available knowledge in the blink of an eye.

This high speed, in conjunction with its distributed "cloud" nature, makes the market the most efficient means of allocating resources conceivable. In regulated industries -- say, healthcare (viz Medicare/Medicaid), media (viz FCC), etc. -- decisions take months or even years, and are based as much on lobbying and pandering as concrete knowledge. The markets, on the other hand, produce an efficient allocation in fleetingly small timeslices, and do so with complete objectivity. At these levels, greed even crowds out corruption.

I believe that those who object to the kind of automated trading described in the OP are dreaming that they could be the ones to score a windfall on some specialized knowledge, rather than have to play on the same playing field (scoured of arbitrage opportunities) that everyone else does.

How can we prove that information actually exists to cause the movements? While you can tap the "wisdom of the crowds" for things like guessing the number of baseballs in a box at a contest, it simply doesn't work if you're asking them a question they don't have any information about.

Given that some of the movements in the stock market have a lot in common with a random walk, you have to excuse my skepticism in wondering how much is signal and how much is noise.

Please note that I'm not taking the absurd position that there's no information to be found. Certainly, there are real events (e.g. SCOX going into bankruptcy) which drive stocks down. Rather, I'm of the opinion that most of the "information" in market movements is noise, not signal. And given things like that "flash crash" we can see that there are times when the noise can completely swamp the signal to a degree I think everyone should be able to recognize.

Interesting. Your predecessors in this thread are actually arguing that any activity that make the stock prices contain less order is a good activity.

Market pricing appears random, but it is not because of a random number generator deciding when to go up and when to go down. It appears random because prices actively resist the formation of patterns, and a chart with no pattern by definition appears random. If a trader recognizes a pattern in a stock that is 100% guaranteed to play out they can borrow heavily and put it all into trading the pattern and walk away with a huge profit. If there's even a small probability that a pattern will play out, then a trader can place a proportionally small bet on it and still have a significant edge over everyone else. But the act of trading a pattern works to counteract the existence of the pattern: if the pattern predicts that the price will go up, then people will buy, thus driving the price up and making it harder for others to jump in until the profitability of the trade evaporates.

Now imagine 10,000 people (and robots) all doing this simultaneously. This is how markets work at the micro level. It may sound like a self-fulfilling prophecy but it happens so fast that the pattern never really exists to begin with -- it's just a way to explain why there are no patterns.

At least theoretically. Most traders (by head count, not dollars) haven't the tiniest idea what they're doing. Luckily, these "noise traders" all tend to counteract each other, and when they do manage to push prices off-course then someone who does know what's going on steps in and pushes things back in the right direction, making a profit in the process. Sometimes there are catastrophic failures, but while they might scare investors they don't affect the ability of the market to predict pricing long-term. The broad markets recovered extremely quickly during the flash crash and without any regulatory intervention.

As for whether the random walk means the pricing is "noise": the market price is an estimation of the fundamental value of the company, which is an imaginary number that is impossible to calculate but is occasionally pinned down when someone gets bought out. Because it is an estimation, and because the fundamental value is also ever-changing due to uncountable external factors (interest rates, consumer confidence, phase of the moon), the result looks like a random walk. It's a noisy estimation of an imaginary number. Neat, huh?

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