[A DOSE OF COMMON SENSE] Inherent Instability

There was a big drop on Wall Street last week. You probably heard about it. It seems that our stock market, the Dow, the heart and soul of our nation’s market economy, dropped nearly 1,000 points in one afternoon before rebounding a bit before the close of the day. This sort of thing doesn’t happen very often and is typically a harbinger of very bad things. Recessions. Market crashes. Bursting bubbles. People tend to take note of these sorts of events and they’re usually tied to some level of impending doom.

So what happened? Well, that’s the worrisome part. No one knew until 5 days later, an eternity in the trading world. That should concern us in and of itself. We should be concerned that our stock market dropped 10% and we didn’t know why.

Of course there was no shortage of theories as to why this happened. Some thought it was the result of a “fat-fingered trade; a typo from a trader who accidentally placed a transaction for a billion shares of Procter & Gamble stock rather than a million shares. It appears that may have been a contributing factor, but I have to agree with Seth Myers of Saturday Night Live’s “Weekend Update” when he quipped that even Facebook makes him confirm when he wants to delete a photo, how could our stock market not have something more robust in place to confirm such large transactions?

The other theory floating around was that the European debt crisis stemming from Greece’s near economic collapse caused investors to lose confidence and the market to drop. That was certainly a factor. The current European crisis has deep implications not only for the Euro currency but the European Union itself, and the global banks who have found themselves in the mix. World events certainly affect our markets, but rarely to the extent we saw last week. The last time world events rocked a market like that was immediately following 9/11. Sure, Greece faces some problems (to put it mildly), but it’s not a 9/11-caliber event.

It turns out, according to a Tuesday article in the Wall Street Journal, that the trigger for Thursday’s scare was the result of a “black swan,” a highly unlikely event that has unprecedented impact. It seems that the hedge fund Universa placed a big bet that, because of the European volatility, the market would continue to fall. That it did.

And this, in a roundabout way, brings me to my point. That whole thing that happened last Thursday? Get used to it.

The reason capitalism has worked for so long is because, despite the inherent risk of buying and selling things, the risk is spread out over such large markets that the overall system is very stable. And that inherent stability is what we have to thank for our nation’s existence and success. This is why the stock market is generally a sound long-term investment; park your money in a mutual fund and watching it increase over the long haul. Average citizens look for stocks with solid companies and than park their sound investment.

But the advent of electronic trading has changed all that. We’ve understood that by using technology and algorithms, we can make bundles of money almost automatically off of fluctuations in the market. We’ve entered what I’ll call a new era of ‘inherent instability‘ because by taking this approach we’re programming the markets to fluctuate. And that, I would think, breeds instability.

I do love today’s electronic trading as much as the next guy. I love that I can place trades effortlessly on my iPhone; it’s quite incredible really. What’s happened, though, is that the name of the game is no longer stability. I don’t buy stock to invest in a company whose brand I trust. I buy stock I think will fluctuate to my benefit and then I get out when it does. That doesn’t add stability to the market. And it’s hard for me to ask if what I’m doing is creating more harm than good. After all, everyone’s doing it, right?

There are many folks like me and more and more big banks getting in on this action. Thursday’s bet made Universa several billion dollars. Folks aren’t investing for stability anymore. They are investing to profit from volatility, and that has the potential to change the nature of our markets and the stability of our nation. Given the interconnectedness of today’s global economy, we’d better figure out the implications of our habits before these black swans come home to roost.

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Ben Murphy

Ben Murphy, founder of The Father Life, is an Adventure Athlete, Writer, and Wellness Advocate who used to be obese. You can ask him your questions at www.BenMurphyOnline.com. He lives in upstate New York with his wife and three daughters.