These are expanded replies to questions from a reader email from a while ago.
It was probably my article about stock option trading
that prompted the questions.
I assume you played the stock market.
Not much, and not for very long, a few years, not several decades.
Were you able to consistently profit from playing the stock market?
Not long enough to talk about consistency, but I did better in stocks. They don't have the inherent drawbacks that options have, such as time value loss and limited length of time you can hold them.
Are all the financial markets rigged?
The big money companies are the ones with congressional lobbyists and friends in regulatory agencies, and whose executives go to top government jobs like Treasury Secretary. Laws and regulations (or the lack of them) are rigged to be favorable to the big companies, but "rigged" can have many meanings. Some of those meanings are more extreme that what I'd agree with.
I think of individual investors as being like children on tricycles playing on an interstate freeway in the midst of 18-wheel trucks. It's the 18-wheelers that are important to politicians, to government, and to the economy. You are nothing to the big players, and they don't mind if they take your lunch money (in fact, they would like to have it), and they don't care if you get squashed.
With regard to the possibility of actual corruption in the machinery of the system, I don't know. In the past, there have been investigations and prosecutions for corruption.
Do you think that only the big market makers and market movers profit?
Certainly the brokers and the exchanges profit regardless of where the market goes, but that's their job, taking fees for processing the trades. At least they receive those fees regardless of which direction the market goes.
However, your question assumes that the big companies profit. The big companies don't do well when trading for their own accounts. Look at all the brokerages from the 1970's-80's that went under (especially in 1987 and 2008) or had to be rescued by merging with larger companies. It wasn't because they weren't getting their commission money from customers. It was because of bad trading, by the same people who want you to trust them to advise you or make your trading decisions for you.http://finance.yahoo.com/news/FBI-to-probe-MF-Globals-use-apf-602167470.html?x=0
Bad trading decisions were also a key factor in the mortgage backed securities and credit default swap financial crisis of 2008. Big companies failed to do a sanity test on the trading decisions they made. It is insane to make gigantic stupid trading decisions but think you're protected from consequences because you've bought trillions of dollars worth of insurance against failure. No one can ever make good on an insurance claim that big. It's like "end of the world" insurance that pays you if the world comes to an end. Obviously, the problem is that the event that triggers your claim also means the collapse of the system, and if the system collapses, you're going right down with it. It does not mitigate or transfer your risk to another party.http://en.wikipedia.org/wiki/Credit_default_swap
Do you believe that in the long run the casino takes all your money?
Real casinos always win because the games played in casinos have rules and probabilities that guarantee that the casino always wins if they can just keep the players playing long enough. The odds are always in favor of the casino, but they get even better over longer periods of time. I don't believe the financial markets are rigged in *that* sense.
Do you think there a way to discern which direction the big players are likely to take the markets?
No. Except that, left to themselves, they'll run up another bubble and be amazed again when it bursts again, and they'll want more bailouts because "nobody" could have seen it coming, or could have prepared for it, or invested more carefully in case it did happen.
Mostly, nearly everybody with an interest wants all the markets to go up all the time and are terrified that they might not. Regulations, laws, policies, and official public statements are all calculated to keep markets going up. In that sense, the system is indeed rigged, in the sense that everybody with the power to influence how the markets behave uses their influence to try to keep the markets going up and prevent them from going down. That is not "like" market manipulation. It is
market manipulation, except that it's a legal kind, and nobody complains because the desired outcome is what everybody wants anyway.
For example, "circuit breakers" were instituted at the exchanges, mandating trading pauses or halts after the market moves by certain percentages. These circuit breakers were put in place after big market declines, of course, and not
after big market advances. The people who devised them had to know that markets fall more steeply than they rise. Therefore, the circuit breakers will be invoked more often during market declines and rarely during market surges. They are devised to keep prices from falling.
The problem is that rigging the system to promote a desired outcome causes the eventual breakdown to be much worse, when it finally happens that the desired outcome can no longer be maintained by reality. The bubble bursts, and it bursts worse. It is like building a levee to hold back a rising river. The higher you build the levee, the worse the flood when it is breached.
That was part of the cause of the housing and stock market bubbble. Business and government were focused on preserving desired outcomes (rising stock market, widespread home ownership) rather than on creating fair and open markets. When home buying sagged, threatening both bubbles, they lowered interest rates so more people could buy. They loosened downpayment requirements so more people could buy, and they looked the other way when institutions and people even broke laws -- just so that more people could be kept buying homes. The economic catastrophe was the result of market manipulation, focusing on a desired end result, right up to the point where the end result could no longer be supported by economic reality no matter how much it was pushed, nudged, or fudged.
In philosophy this is called a tradegy of the commons in which everyone pursuing their own best interest acts in a way that results in destruction of all their interests.http://en.wikipedia.org/wiki/Tragedy_of_the_commons