Is it just that they're being that much quicker in smoothing out prices of stuff on the stock market?

I'm not being snarky, would just like to know.

Another slightly different topic: the trend during the Bush boom years is that the so-called 'smart people' graduated to the financial industries which is where all the money was. This is opposed to the people who I regard as smart and gutsy trying to do something new and of probably greater benefit to other people such as starting your own internet company.

Is it just that it's easier to make money from money as opposed to doing something that's probably more helpful but usually pays less?

Think of sports tickets. There is massive inefficiency in the primary market, meaning tickets you buy directly from the arena or on TicketMaster. One inefficiency comes from all the season ticket holders who skip the majority of the games and only go to the ones they actually want to see.

We can fix this inefficiency on a secondary market (the scalpers, StubHub, etc). A scalper might make a decent take by finding season ticket holders and buying the unused tickets. Then, the scalper sells the tickets to fans who waited too late to buy (or won't pay full price).

Now we think the scalper is evil, because he just made money without "adding value." Except he did add value... the season ticket holder and the last-minute-fan wouldn't have found each other without great effort. Both ended up happier than if the scalper didn't exist. Also, the scalper takes on some risk... he guaranteed the price he paid to the season ticket holder, had to hold the ticket, and then determine the correct time to sell. If he held the ticket too late (or got too greedy), the game would begin and he'd have a worthless ticket!

We also need to somewhat regulate scalpers because if they have too much of an impact, they can seriously distort and manipulate prices (a very wealthy scalper can buy all the tickets to a popular game and sell them all at 10x the price).

This analogy isn't perfect for high-frequency trading or all market making, but I hope it shows why arbitragers both add value and reduce risk yet seem evil to all the participants.

The taxpayers made that decision, so it's unclear why you think that the recipients are evil.

I think that the taxpayers made the wrong decision, but ....

The advisors weren't significantly different from the representatives. Does that make the representatives more or less evil than the advisors? Does it matter?

Given that this is how things are going to be if we have this sort of regulation, are we really benefitting from this sort of regulation?

I think that we should always evaluate based on realized benefits and incurred costs, not desired benefits and promised costs. However, our actual policies show that most people disagree with me.

As to extortion, the "everything is failing" stuff came from regulators who are still in place. By contrast, the admiral and general in charge of Pearl Harbor on Dec 6, 1941 were replaced almost immediately....

If you setup a fair exchange where genuine buyers bid and genuine sellers offered and everything cleared at a specific time at one price for everyone, sellers and buyers would get better prices, which everyone would think was fairer, and all possible exchanges could occur.

The only winner here is the scalper though. The customer Microsoft, Nintendo and Sony are put in a lose/lose position.

The scalpers have the highest profit margin while the real fans who buy the extra games have $500+ less to support the companies that are bringing real value to the market.

The customer has a choice on whether or not it's worth the purchase. To the customer who values the item (Wii/Sporting Event/whatever) over the (inflated) cost, it is a net gain, not a loss. To the person who doesn't value it above the asking price, they don't have to pay, and they don't have to get the item.

I bought my Wii for an inflated price on eBay and I have no regrets about it. I have a friend who bought her Wii at an even more inflated price (almost double the asking price, if I remember correctly), and she also had no qualms about it.

Furthermore, scalpers who wait in line for hours to buy tickets/game systems, and then flip it for profit are essentially providing a paid service to those who are too impatient, late, or otherwise incapable of buying said items when they go on sale, knowing that there is a limited supply that will not meet all the demand.

That is too short sighted of an analysis. Too much value is being lost by unnecessary overhead. Have you noticed how overhead is something to be eliminated by every company except the middleman's themselves?

With your reasoning, would it be a "net gain" for someone pay more for oxygen than you if some scalper managed to monopolize all the oxygen? There are probably plenty of people richer than you that would pay for the "true" (sarcasm) value of oxygen. Would it be a "net gain" for someone to buy up all the land and charge a million euros per square acre? Somehow, I think your answer to this question will still be yes, but I hope I've managed to convince everyone else.

Furthermore, scalpers who wait in line for hours to buy tickets/game systems, and then flip it for profit are essentially providing a paid service to those who are too impatient, late, or otherwise incapable of buying said items when they go on sale, knowing that there is a limited supply that will not meet all the demand.

There are plenty of people who were willing to buy it for the initial price instead of the inflated amount.

The problem here is that you are using the broken window fallacy. Just because someone artificially jacked up the "demand" of an item doesn't mean that the item is really worth more.

Take for example the recent housing bubble. People scalping houses forced the legitimate buyers to take out huge mortgages that they eventually couldn't pay off. If you think there was value added there, I don't know what will convince you.

Most of the people who bought houses are also scalpers; they bought a house in the hopes that it would be worth more later. "Real estate never goes down!"

The cost of renting went up along with the boom and unsurprisingly went down with the bust. Everyone was forced to pay more except for those who already owned a home.

Where do you think the leasers got their homes? Do you think that they wouldn't raise their prices when other options were priced much higher?

"Most of the people who bought houses are also scalpers; they bought a house in the hopes that it would be worth more later. "Real estate never goes down!""

Hindsight is 20/20. During those economic conditions, you could either rent overpriced accommodations, or you could take out a mortgage with a lower % interest than how much homes were appreciating yearly. This was a ponzi scheme where the timing of the bubble was controlled by the financial giants' tolerance for risk.

If you did not join in this fiasco, you risked losing purchasing power compared to everyone else. This is equivalent to you putting your money in a 0% interest account while everyone else puts it in a 5% interest account. I am willing to bet that the majority of the people here did not know when the bubble was going to burst, including most of you who are now saying that "those dumb speculators shouldn't have bought a home back then" (see how this is bad for liquidity if you can't buy a home for 3-4 years?).

Scalping is also theoretically bad for the market. The market is not optimal when buyers are paying the maximum amount. In such a condition, you have decreased liquidity as buyers are forced to buy less since everything costs most of their money. You might just buy food and shelter, and try to be self sufficient on everything else. This is not conducive to a vibrant economy.

The market is optimal when sellers are selling at their minimum amount. The ideal market thrives on competition. Liquidity is increased and you have incentives to use the extra money to drive other sectors of the industry.

Take for example text messaging. It doesn't even cost 10 cents per message, and people would even pay 20 cents per message. But does that mean a text message is truly worth that much? Absolutely not! The phone company has lost that much interest into improving their existing services rather than trying to extract as much as they can from their consumers. Artificial scarcity only helps businesses/scalpers take advantage of the consumers.

http://bigpicture.typepad.com/photos/uncategorized/2008/05/1...

If you did not join in this fiasco, you risked losing purchasing power compared to everyone else. This is equivalent to you putting your money in a 0% interest account while everyone else puts it in a 5% interest account.

Yes, I would have lost if housing turned out to be a good investment. This does not change the fact that your "legitimate buyers" were speculating.

Also, if you are comparing scalping to text message prices, that analogy would only make sense if a single scalper (or a small number of scalpers) holds a monopoly over the market (either in tickets or houses). That's obviously wrong.

First of all, just because the ratio went up doesn't mean that rentals didn't go up as well.

Second, what are the units are that graph? 25? That's definately not 25x unless you've normalized it to the 1900s or so which is silly. That graph has an exaggerated axis.

Third, the metric for price-rent ratio is rather arbitrary. How is a rental for 12 months ever equal to the cost of a house? A house is not entirely equivalent to an apartment to be compared in this manner, and the number of houses for rent is inversely related to the market price.

Yes, I would have lost if housing turned out to be a good investment. This does not change the fact that your "legitimate buyers" were speculating.

The point is the people who were scalping first forced an artificial panic on the system. If they did not have the power to do this, people wouldn't have been highly compelled to follow them. Therefore scalpers are bad for the market. This is equivalent to a "pump and dump" scheme which is illegal when trading equities.

Also, if you are comparing scalping to text message prices, that analogy would only make sense if a single scalper (or a small number of scalpers) holds a monopoly over the market (either in tickets or houses). That's obviously wrong.

No you are completely missing the point. Scalpers have at least a regional monopoly. Is text messaging a regional monopoly? Yes. Did housing speculators buy up whole plots of real estate in certain areas? Yes. Did wii buyers hold a monopoly on wiis when they bought out the limited supply in stores and put them up on ebay? Yes. That's the entire point of scalping, to create an artificial lack of demand through a monopoly.

  The only winner here is the scalper though.

If I remember correctly, there WAS a console flip fiasco in Boston (PS3 I think), where the scalpers who waited in line all night didn't wind up profiting.

Edit: first link I found, probably many others... (http://kotaku.com/gaming/ps3/some-scalpers-give-up-return-ps...)

In the example you just pointed out, Sony just lost market share from that because the scalpers took those consoles away from legitimate gamers who may have even switched to the wii or xbox.

And since we all know that the profit is mostly from the games, not the console, this was a lose/lose situation for Sony, the consumer, and in this case, the scalper.

You have to think of the value people assign to their time. The console flipper simply converts the price of the console from ($300 + 10 hours) to ($500). Think of it as the ultimate owner hiring the person to wait in line for $20/hr.

How is this a problem, especially one requiring regulation? Nothing has changed from your original formulation, except apparently that he's now making 'too much money.'

It's better the scalper sell 50% of the tickets at 10x (and let 50% rot) than all of the tickets at 2x (and have nothing rot).

The scalper will let some tickets rot to preserve the 10x pricing because this is a repeated game. If people know that he'd rather let tickets rot than lower prices at the last moment, they'll have no choice but to buy at 10x or miss the game.

Also, first-party ticket vendors have been known to actively partner with third-party resellers to essentially eliminate the original market. Ticketmaster, for example, owns an online scalping service (TicketsNow) and there have been repeated allegations that they give preferential treatment to their own scalping subsidiary.

    represents the creation of inefficiency rather than the remedying of it.

With scalpers, the venue venue has their risk removed (they lock in their sales early), and the scalpers increase liquidity by removing the venue's monopoly power over pricing the event. And price discover is better.

Now either the consumers are able to buy the tickets from the scalpers in a competitive market (and often with increased convenience), or the scalper can destroy the tickets and nobody can turn up the the event. They generally won't - that's irrational. Even if they did - it's not an ineficiency for the purpose of the original marketplace. In fact, it creates opportunity for extra production: the venue can arrange a late-entry-for-unfilled-spot policy which allows them to get people in and sell some tickets twice.

Or the venue can detect scalpers and create a dynamic price market of their own and maximise their volumes.

In the situation where multiple scalpers get the tickets and plan to sell them, there has been a massive gain in efficiency. The scalpers have removed the venue's monopoly power over ticket prices and created a second market place which will have more effective price discovery.

Either way, the event provider is focussing on what they're good at, and the scalpers at what they're good at.

Scalping is entreprenerial in spirit and good for the system in practice.

If scalpers are able to buy out an event in a matter of seconds/minutes after tickets go on sale, they will manage to artificially inflate the price for tickets (since the only way to get tickets will then be to pay the scalpers' prices). In effect, they will have decided that the natural supply/demand situation is unsuitable to them and manipulated the market to create an artificial scarcity. While this is to their own advantage, it is not efficient with respect to the ticket market.

    In effect, they will have decided that the natural
    supply/demand situation is unsuitable to them and
    manipulated the market to create an artificial scarcity.

The interests of the ticket maker and the efficiency of the economy are separate considerations.

Even in the situation where one scalper gets all the tickets, if they sell them to people who are themselves then free to onsell them then even this creates a more efficient market than what you have when the venue has a monopoly over the direction of transactions.

I always thought it was strange that event venues were able to coax legislators into introducing anti-scalping legislation. It's only now I see the arguments being brought against scalpers that I appreciate the murkiness of the issue when pitched from certain perspectives.

The same total sum of goods and services is available with scalpers buying up the supply, but those goods and services are now provided at higher total cost than otherwise. This is, so far as I'm aware, the definition of inefficiency and consists solely of artificial inflation of prices.

Although this isn't the universal case, because scalpers can compete against the hosue at a later point in the market, and offset attempts by the house to segment the market, and can lose out at times causing sale at a loss to themselves.

But that's unrelated to market efficiency. People in this thread are trying to define "seller not getting what they want" or "particular type of consumer not getting what they want" into market inefficiency, and it doesn't work like that.

I'm not an economist. Perhaps I'm wrong, but in this case please make the case in terms of a definition you can cite.

(In practical terms, they seller could reach that aim by giving people a cashback at a random time during the event for those who turned up - for example swapping a single ticket for a cashback at the end of the show as people were leaving the gates. The reason venues don't like scalpers is that they don't like price discovery because of reasons like these: (1) they want to be able to make a killing on late tickets, even if it's only for a few events per year and (2) they want to be able to sell tickets to poor people through some mechanisms at one price, and tickets to richer people through different mechanisms at another price, such as through coupon clipping or discount books or through ticket offices in poor areas, (3) they don't want tickets won through competitions being given away. That way they get to charge wealthier people a higher price than time-rich people who are typically poorer. That's inefficiency.)

PS: Consider rather than a ticket scalper you had a group of bandits charging a toll to cross a bridge. They are not adding value to the experience of crossing a bridge and they are not helping the people who made the bride. So while arguably they increase GDP it's not a net gain for society.

http://en.wikipedia.org/wiki/Deadweight_loss

Deadweight loss from monopoly pricing power.

I don't have any formal training for credentials, but here's how I've come to think about it...

The markets (of which the stock market is one, but the venture capital and private equity markets also count) are capital allocation machines.

This is easier to see in venture capital. The market for startups makes it possible for promising startups to raise capital. It also "encourages" "bad" startups to die.

It's capital allocation.

Same thing for the public markets. They give companies access to capital (either through debt or equity) at a cost that's proportional to how valuable the company is, or is likely to become.

So society, through the open markets, gives Apple and GE the opportunity to raise capital.

Dying public companies, on the other hand, have a really high cost of capital.

And my favorite way to think of capital is man-hours.

So if you were king, and you were responsible for allocating man-hours to different projects, this is the same problem as capital allocation, and it's the same problem that securities markets solve.

They also provide liquidity and at scale the operational overhead goes to zero.

They also provide opportunities for investors to hedge against inflation, participate in society's long term growth, etc.

But the most important function from a societal standpoint IMO is very efficient capital allocation.

I don't have a beef against stock trading in general, just the uber hyped money generating system that it fuels and the fact that it seems to make the rich richer and drain the brain market who in my opinion should be doing something more productive - making stuff that could be helping people even if it's in often unremarkable or in a horseshit fashion like Twitter can.

Then why is that? Why free market beats any other forms? Because it computes prices better than any single intelligence known in this universe and it's possible by massive interaction not just between real demand and supply sides but all the participants who care about price. The group of people who care price the most is traders. Traders are the participants whose job is all about pricing, or balancing between demand and supply. Whether or not it's profitable, it's enormous contribution to the price mechanism of free market.

Actually, all the producers in any kind of markets are essentially traders. Whether it's manufacturing, mining, or agriculture, the profit can be made only from meeting price right, not just from hard working oblivion to real demand and supply. If you broaden the concept of trading in this way, you will realize traders are everywhere and they're important as much as any other kind of physical labors. An Internet start-up is also a trader. It can succeed only in the market where it can make successful trades between its product and the cost of what it produces. That's the essence of trading and we all do it every single day.

They used to have this graph that showed the DOW never lost money in any ten year period. It wasn't adjusted for inflation, do that, and you'll hear a giant sucking sound. 401K chumps don't stand a chance of beating inflation, they're sole purpose in life is to add volume to the markets so the skimmers, who add far less value than they take, have someone to fleece.

It's white collar crime: if you can pay off some legislators and capture a couple regulatory agencies, then it's almost legal, though it's far from moral.

Joe 401K should seriously consider keeping his retirement money closer to home where the electronic thieves can't get their hands on it. Let the hedge funds make the long investments. I know corporations need to issue stock in order to grow, but the hedge funds just sit in between the investors and the corporations and manipulate the market.

Joe 401k doesn't have much choice in the matter; the tax system leads him in by the nose.

Here in the UK, the housing bubble was largely caused by individuals looking for a viable asset class for their retirement. The stock market was out due to a combination of poor returns and Gordon Brown's tax raids on the pension funds. So we see when regulators meddle too much, lots of honest individuals making the correct decision for their own and their own family's future leads to negative effects on the economy as a whole.

However, the actual effect of arbitrage is to make things that are already reasonably liquid much moreso, which means that the benefit to buy-and-hold investors is low. Illiquid stocks are avoided by arbitrageurs (too risky). So the net benefit to society is nonzero, but minuscule. Plus, rich people are the biggest beneficiaries, which makes it even less appealing.

Trading isn't something you do to make the world a better place. On the other hand, it's one of the few high-paying finance jobs that doesn't make the world a worse place.

Anyway, I think most people are confused because they think of Wall Street as though it is all about equities. Equities are a casino because the public treats them that way. If people learned not to throw their money away in the stock market, maybe equities traders would be in fixed income and derivatives instead, where they provide a much more important service.

These computer algorithms seem to be really good at making things very liquid, is there any inherent danger in that? I seem to remember reading an article that the automated nature of the high-volume trading machines posed a danger in and of itself.

The average investor, however, doesn't care about the loss of < 0.01%. Broker fees are much higher than that.

Hedge fund traders do actually make markets more efficient, and so those who trade on them get better deals. This is not to justify finance having been enormous talent sink that it has been for the past 30 years; society would probably be better off with these people in science and technology, but the net benefit to the world produced by these people is positive.

The top high-frequency traders though multiply that minuscule effect by millions (amounting to a much higher-value add as a whole to society), which IMHO justifies their high earnings.

What would justify their earnings would be if they made less money than the humans that preceded them would have.

Two people want to exchange. If a algo trader might quickly hit the seller, then a second later sell at a higher price to a buyer who arrived later, the buyer is worse off in price than if the seller had to wait. The seller gets to sell a second earlier, they probably don't care.

You can't make money unless you are a mint. Traders extract money from the market that would otherwise go to others. They produce no goods that we can consume. There is value to allocating investment funds to useful endeavors. It is not clear that algo's do much of this.

You want algos.

My theory is that it has something to do with them being successful and making millions without having to venture out and start their own business.

I mean, there are only a couple of roads that lead you to riches. Building a successful company is one of them, being successful in finance is another. I guess on this site, we've all chosen more or less, one road, so we have to rationalize to ourselves why we didn't pursue the other.

Or at least that's just how I feel sometimes.

John Malitzis, vice president of market surveillance at the New York Stock Exchange's oversight body, told a conference in September that he has seen examples, both in U.S. markets and elsewhere, of computer algorithms malfunctioning. He calls them "algos gone wild."

Couple 'algos gone wild' with the fact that 60% of trades (article's figure) are HFT algo trades and you have the potential for absolute chaos in the markets. Many of the algorithms mimic each other (crowding into the same trades). Some algos are programmed to essentially hunt down other programs and exploit things they expect them to do.

As the article states, the high frequency traders have moved beyond equities into options. Imagine if we see a global cap and trade scheme implemented, with a marketplace for carbon credits. Could algos 'gone wild' drive the price of carbon credits to some absurd extreme (think the speculation-fueled oil bubble in summer 08, but in reverse) that dramatically influences how much CO2 our collective industries emit?

Software bugs combined with human error are a source of danger though, such as in the infamous Japanese trading disaster (someone transposed the size-- 1-- and price-- ~600000 yen-- on a short-sell of an IPO, effectively giving away more shares than existed). The fail was not so much that the clerk put in a bad order, but that the exchange software wouldn't let the firm cancel it, leaving them to eat $225m in losses.

http://en.wikipedia.org/wiki/Mizuho_Securities

http://www.physorg.com/news8901.html

But I thought exchanges could retroactively cancel trades in some cases?

I do believe there is some truth to this, a couple years ago during the "quant bloodbath" we saw a major down swing across almost every quant fund, because they were all employing generally the same strategy.

At the same time, with the trend towards more complex markets, quants will continue to rise in demand at Wall St. firms (especially since their profits dwarf those of the IBanking division). However, that does not mean you have to be a financial engineer to crank out market beating returns. Traditional value strategies will probably continue to be just as good and beat the market over the long term.

I don't think so; the most you can do on average is to match the market return unless you have insider information which is clearly illegal. This is because so many has tried the traditional value strategies that the law of large numbers set in.

See: The Super Investors of Graham and Doddsville http://en.wikipedia.org/wiki/The_Superinvestors_of_Graham-an...

How the Small Investor Beats the Market by Greenblatt, Pzena, Newberg (Journal of Portfolio Management, 1981)

More recently, James Montier has released research at Societe Generale reflecting the fact that Graham and Dodd-style investments also beat market averages.

The problem that arises nsoonhui is that most investors lack the emotional discipline which is necessary to invest in these types of companies, because of the psychological biases (people have a hard time embracing contrarianism, they usually cannot stomach the occasional stretches where value under performs the rest of the market, i.e.: dot com bubble). This is precisely why the law of large numbers has NOT set in. Many investors will pick up value investing and then drop it once it under performs. So, inefficiencies in markets continue to persist.

Any investment strategy becomes less useful when large numbers of people pile into it. They bid up the assets that the strategy dictates they buy, which raises prices and lowers returns. I ran some cross-market analyses of stocks in 2006 when I was working at a financial software startup. I found that basically everything was overvalued: there were no values to be had in the stock market at that time.

A true contrarian right now would hold cash, in the form of physical U.S. dollars. What's the one asset class that everyone is certain will decline? Cash. However, there're fairly good reasons why everyone thinks this, so even now the picture's pretty muddled.

I guess you weren't looking at special situations/event driven investments were you? Because I know plenty of people who did well during that year taking advantage of inefficiencies like spinoffs, merger arb, and cap-structure arb, and so on... these are typically the types of investments that Buffett refers to when he said that if he was managing 7 figures he could do 50% a year.

To be contrary to this guy you would be short now:

http://www.nytimes.com/2009/12/03/business/economy/03econ.ht...

"There’s nothing here to support double-dip fears."

You want to be overall long volatility and short the market.

You can do that by buying some far out of the money puts, and possibly this fund by selling some in the money calls, and limit your down side by buying some out of the money calls.

http://www.reddit.com/r/IAmA/comments/991kc/my_2009_adjusted...

I've sadly lost touch with him, but there are a number of financial math grad programs out there. If you're really passionate about this technology, try one out and do some internships. Oh - and don't do it because you think you'll make millions.

Whatever happened to value-driven investments... </facetious>