Guest Post: A Common-Sense View Of The Stock Market

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

A Common-Sense View of the Stock Market

Common sense leads us to the "obvious" conclusion that the U.S. stock market is a rigged skimming operation that is essentially a form of legalized, officially sanctioned fraud.

Active traders and professional money managers already know how the U.S. stock market actually works, but Joe and Jane Citizen, whose pensions generally depend on the market in some way, typically do not. This entry is for them. Today's financial markets are endlessly complex, and this complexity implicitly serves to mask the true nature of market operations.

Most of this complexity can be boiled away with zero loss of understanding. Indeed, manipulating this complexity is what earns the big bucks on Wall Street, while boiling it away earns the big bucks for commentators and analysts. Thus complexity serves the financial industry extremely well.

The first and most important thing to understand about the U.S. stock market is how few humans are actually involved in the decision to buy or sell large blocks of shares. Machines do most of the trading. High-frequency trading (HFT) computers buy and sell millions of shares in milliseconds: Zero Hedge: From Chicago To New York And Back In 8.5 Milliseconds:

The reason why little if anything can and will be done to fix the persistent threat to capital markets that is HFT is two fold: i) none of the current regulators understand anything about modern market topology, and ii) HFT is so embedded in markets that unrooting it would result in a complete reboot of "fair" stock valuation.


That said it is always amusing to observe as more and more people get in on the scam that is the "equity market", now completely dominated by robots which do nothing but accelerate and perpetuate momentum moves - after all it is all they can do in lieu of being able to read financials, or anticipate events. Remember: it is always the market that makes the news, never the other way around.

In essence, HFT is a gigantic skimming operation that exploits tiny differences in the bid/ask prices of stocks to buy and sell millions of shares for slivers of profit that are multiplied by millions of shares traded in seconds. Raging Bulls: How Wall Street Got Addicted to Light-Speed Trading (Wired Magazine, via Zero Hedge).

Other computers are programmed by math-wizard "quants" to trade momentum and technical signals. Since everyone in today's markets has access to the same technical triggers and data, computers are programmed to respond to these signals.

For example, days with large pre-market buying of S&P 500 (SPX) futures contracts tend to open up, so trading robots will buy at the open and ride the momentum up. If the market rallies by 3 p.m., the odds of it closing higher are very high. This is how keying on momentum yields low-risk profits if the trading involves millions of shares that are held for microseconds, seconds, or minutes.

Here's another example: if technical analysis (TA) has identified SPX 1,366 as a key level, then once the market surges above 1,366, the trading robots will buy into the move.

The second important thing to know about the stock market is that central banks and governments intervene as buyers to trigger rallies and put floors under declines. As noted above, huge buying of futures triggers opening rallies. It is a poorly kept secret that central banks or officially sanctioned but cloaked "plunge protection teams" are doing the buying.

Once again it is relatively easy to steer the market because humans and computers alike are keyed on certain well-known technical signals. For example, if the 200-day moving average of the SPX is 1,300, and the index dips down to that level, computers are programmed to sell if it breaks below that support level or buy if it spikes above it.

Authorities need only issue massive buy orders at these critical levels to "stick-save" markets from declines.

As regular folks continue to pull their money out of the market, either tiring of losses and volatility or recognizing it is rigged to their disadvantage, trading volumes have declined, making official but "secret" intervention both cheaper and easier.

Just as the U.S. stock market now depends on high-frequency trading, it also depends on official intervention to stop any decline.

How is it legal for HFT computers to skim profits that are unavailable to human traders? Clearly, this is legalized fraud, or if you prefer, embezzlement.

The third thing to know about U.S. stock market is that their operations are opaque, invisible, and hidden from the citizenry and non-Elite human traders. How much of the market volume is computers skimming via HFT can only be estimated. Official buying to spark rallies or stop declines dead in their tracks is also hidden from the citizenry.

Huge volumes of shares are traded off the public exchanges in so-called "dark pools" that are also hidden from the citizenry and non-Elite human traders.

How "fair and open" can an exchange be when its critical operations are hidden from public view? Answer: it cannot be fair and open. It is rigged to favor Elite players, who are allowed to legally skim billions of dollars in profits by means which are unavailable to non-Elites investors.

This vast skimming operation is enabled, enforced and supported by the Central State and the (privately owned and operated) Central Bank of the U.S., the Federal Reserve.

The Pareto distribution can help us understand how the market really works. Though it may well be that a mere 10% of stock market volume is human-traded shares, let's assume the 80/20 rule applies and 80% of the shares are being traded by 20% of the traders, most of whom are machines.

Taking the distribution one step further, we can estimate that 64% of the volume is executed by a mere 4% of the players.

The fourth and last thing to know about U.S. stock markets is that this skimming and intervention have left the markets extremely vulnerable to collapse. Official but secret intervention is called the "Bernanke put," meaning that the Fed will intervene to keep the market aloft, regardless of what is happening in the real world of the global economy.

This faith in central-planning manipulation of the market has encouraged an extremely high level of complacency in traders; they confidently trade the market higher, knowing that the Fed will never let it fall.

But this leaves the market exquisitely vulnerable to high-volume selloffs that roll right over the Fed's rather modest buying power.

Since HFT and quant trading robots are programmed to buy and sell at commonly-known technical signals, if certain levels are broken to the downside, the selling will quickly avalanche as trading machines issue sells.

Leaving 80% of the volume to programmed computers leaves the markets extremely vulnerable to cascading momentum selling. If you live by momentum trading, you also die by momentum trading.

If you wanted to design a system that was eventually guaranteed to crash, then you'd design a system that is dependent on opaque official intervention and HFT/quant computer trading for 80% of its volume. That's the system the Central State, the Fed and the financial Elites are supporting and enforcing because it's an enormously profitable skimming operation that is also a supremely useful tool for managing perceptions: if the market trend is always rising, then the economy must be improving.

This is of course a false correlation: the market is hitting highs while the global economy is unraveling.

Beneath the surface stability, the Fed, the State and the financial Elites have constructed a terribly unstable system for skimming unearned wealth and propping up a propaganda facade of economic "improvement."

If watching a tiny Elite skim billions of dollars from the real economy with the aid of the Fed is your idea of "improvement," then by all means, buy the rally. Just be ready to sell in 10 milliseconds.

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diogeneslaertius's picture

Answer: it cannot be fair and open.

Thomas's picture

Ah, just conspiracy theories. Everyone knows that markets in which trillions of bucks roll around the globe everyday are free and clear of folks conspiring to get some of it. [/sarc]

AldousHuxley's picture

just buy s&P500 index etf with lowest expense and hold that shit.



Skateboarder's picture

In computing and otherwise, we call this Ahmdal's Law. If 80% of your water is spent on agriculture and 20% in city use, doing your best to save every drop of water in that 20% doesn't make quite the difference as does maximizing the use of the 80%. Similarly, if algorithms are controlling 80% of the market, humans won't make a rat's ass difference in the whole by being responsible with their 20% (though they are not lol).

So yep, it indeed cannot be fair and open while there are nonhuman players involved. Ban algorithmic/computer trading...

saturn's picture

Ban the goverment, central banks and regulators from trading too.

Snidley Whipsnae's picture

The FIFTH and most important thing to know is only a damn fool would participate in the stock markets.

If you look around the table and can't spot the sucker, it's you. least in Vegas you get free drinks ... and they don't change the rules at the craps table while the dice are in the air.

john39's picture

our glorious leaders.... any wonder why the US is so hopelessy screwed up?

larz's picture

no frickin comment - this woman, no these people in DC take themselves seriously!!!!????

madcows's picture

Yeah, but they got away with it in Office Space.

govttrader's picture

The author has missed out on the most important point about model trading (what the HFT algoS do).  First, nobody cares about making the bid ask spread froM the algo...thats not the game of the independant trrader.  There are large macro hedge funds with billions of AUM...and they detemine wherE the markets go, and they don't operate in a vacuum (remember, for every buyer there is a seller).  They don't do this on a whim...they use a cheap..sell expensive..and every once in a while when the broad market is susceptible...they create large price swings thru leverage.  Forget complaining about it....understand what these models do...and FRONT RUN THE ALGO

larz's picture

well said gov there is opportunity dont buy the negative hype of how hopless it is adjust and stay disc.

Debtonation's picture

So what is the ultimate solution to this?  Is the government suppose to ban HFT?  Usually the government screws everything up so I don't even know if that would work.

crawldaddy's picture

solution is easy, TAX each trade.  Can be a penny, it wont effect human traders, but will make all HFT trading un profitable and thus they will stop.

casey13's picture

Restoring the uptick rule would be a start.

mammoth mo's picture

You assume a solution is wanted.

The trading system is the solution.  The problem was too many people with access to knowledge could figure out how to make money just like the big brokers.  When this happened new millionaires were being made based upon this access to information.  The people who had been given money all their lives and controlled the market through their access to information got peeved.  They were never interested in a "fair" system only the illusion of a "fair" system as they took your money.

This was their correction.  Now they are back in power and the little guy is once again scrambling trying to catch up. 

The solution for dealing with criminals is to avoid them as much as possible.  One other thing, the government should it ban HFT's would only do so if the elite's replacement was already in place to make it even more money.  If you are looking for the government to save the people you are looking in the wrong place.  The correct order would be the people save the people and make the government do the right thing by putting good people into office.  Thats also difficult but not impossible.


AlaricBalth's picture

If you rely on the government to protect you, who will protect you from the government?

Hannibal's picture

Keep on stacking while its still cheap!

Meesohaawnee's picture

but but jeff macke one of the biggest embarrassments on the planet is saying Bears are whiners.. . Check out what the latest clown hour show says .. of course bears are whiners in a rigged market.

NEOSERF's picture

So if so few humans are involved on a day to day basis and the government (or its minions through the TBTF banks) will step in and always create a floor and up = confidence, why would we assume that there is any more risk of a collapse?...clearly those in charge of this confidence metric won't allow any more than a 10% decline and even that seem unpalatable at this point as the country is always on the verge of some sort of chaos...I assume that once there is anything looking like a precipitous decline, Jamie and others issue the "turn off the quants, get off autopilot" command and turn on the BTFD algos after say 45 minutes of that decline some morning...we have seen this 10s of times in the last 2 years, any large morning drop comes back.

gnomon's picture

If it isn't in your hand, it is not real and subject to being stolen from you with little or no effort.  

If it is in your hand, it is real and the MFer that wants to steal it will have to go through you and your shotgun/AR.

SWCroaker's picture

Agree.  Have been forcing myself to treat it as true for the last 2 years.  Working so far.

Got to admit I have not been able to put down fear, and ulcers are part of the price I pay. 

Maybe two scenarios lead to a sizable crash:

1) The idiot algos get in a reinforcing negative feedback loop to the point where the gov's Hand Of God can't put a stop to things.  Ugly day with auto shut-down hit, some schmuck goes under the bus as the Fat Finger de jour, and lots of cancelled trades to mop up. 

2) The gov decides it is time for a "convenient crisis", to create the desperation needed to allow them to ramrod in the next big set of domination steps. 


I think maybe the ulcers are sane after all.

mammoth mo's picture


Collapse is not the risk.  Crashed is the risk.  In a general ponzi scheme those at the top cash out when the amount of suckers at the bottom start to dwindle.  With the amount of suckers dwindling it's only a matter of time before everyone in the system realizes it's a farce and walks away to play another game. 

What the people at the top do is plan a crash to create another ponzi game.  Yeah that one was crooked but this is legit.

So as the suckers get smaller the more there is a chance of a crash.  The question is what new game will be created. 

In addition, you must realize that the people at the top are never hurt in a crash.  The people trying to get to the top are.  The crash takes all their money invested in the ponzi.  The people at the top have cashed out and have all their money available for the new game.

For example, the newest sucker pays their upline 100% of the ponzi tax, their upline pays 50% of that to their upline, and so on and so forth.  The people at the top aren't putting anything into the ponzi other than their lip saying you have to get in.  Every dollar they collect goes to a bank account somewhere a million miles away from the ponzi.  Most of it untracable back to the ponzi in case of legal issues.  Everyone else is paying up to half to their up line and hoping their down line works hard enough to put them in a position where they are on top.

A collapse before you hit the top pretty much wipes you out with no chance of getting it back.

The crash is caused when the people at the top - need new suckers and a new game.



mammoth mo's picture

One last thing when there is a collapse or planned crash - there will be a million reasons why.  The question is what is keeping it up now?

john_connor's picture

Love Charles Hugh Smith posts.

busted by the bailout's picture

"Program trading" was cited as the big cause of the '87 crash.  I thought they fixed that. 

Are you saying it is even worse now? 

That would be shocking!

Hype Alert's picture

This is of course a false correlation: the market is hitting highs while the global economy is unraveling.


Which only reinforces people to stay the hell away.  They saw the internet bubble pop, they saw the housing bubble pop and I'm sure the more the market goes up as the economy implodes, the more weary they are of it.  Central planners have trouble realizing their limits.


To add to this, I think there is a natural fear of heights.  Central planners want to force people into the high risk areas, but the only way forward at this point is to convince people that the Weimar effect is in place.  How is that a good thing?

JR's picture

When the central planners deliberately gamble away the very homes people live in and nonchalantly toss the nation’s lowliest worker out on the street, there is no limit to the depth of their criminality or to the damage they will inflict if they smell a profit.

These investment bankers are on the economy like a rat on a cheeto.

Their enemy is freedom and open government - because where there is freedom and transparency they can’t exist. They are like cockroaches: when you turn the light on, they run under the refrigerator.

This fight has been coming on for a long time and now we’re right in it. You bring a Third World country into our nation and you try and operate an economic system that benefits you, and you are a fool. It’s a myth. This economy has foundation problems.

Thanks, Charles.

DeFeralCat's picture

When Germany says Nein to Spain's 900 billion euro bailout we will see what kind of floor can be put under the market. Draghi asked Spain to ask so we are just waiting on Rajoy to pick up the phone. The problem is that Obama and Geithner are pleading with him to wait until after the election. We are sitting on the precipice......

busted by the bailout's picture

Most people I hear on Bloomberg think Germany will say yes, in some fashion, this time.

Also, ZH already pointed out that O wants Rajoy to ask NOW.  This will pump the S&P higher and instill good feelings about the economy thus improving his chances at re-election.  Waiting until after the election does not seem logical.

DeFeralCat's picture

The SPD opposition party is for it, the CDU has not stated anything publically as Ms Merkel is away. The two junior partners are completely oppossed to the idea for all of the obvious reasons. Regardless it would require a change to the Constitution and a referendum for them to create Eurobonds. This cannot happen in the shortterm. Thus, Rajoy asking today starts a process that takes months to evolve. The damage will be done. Financial Times 8/9/2012 pg 4

busted by the bailout's picture

Thanks for your comment. 

I believe you are probably right, but his asking is all the markets require to price in the bailout.  And that might be enough to last through Nov 6.

Meesohaawnee's picture

The second important thing to know about the stock market is that central banks and governments intervene as buyers to trigger rallies and put floors under declines. As noted above, huge buying of futures triggers opening rallies. It is a poorly kept secret that central banks or officially sanctioned but cloaked "plunge protection teams" are doing the buying.

never more so obvious than last fridays pre employment ramp up at 6am ct.. order from obummer if im a betting man.

jmeyer's picture

Unless market " makers " are channeling from the future what difference does it make ? Algos of all kinds are still made by humans. It's still a market of participants trading against each other using whatever clever ideas they or their computers come up with. Insider info gives the owner of that info an unfair and illegal advantage but look back at any data set of stock movements and try to see what was happening whether by fair or unfair practices. Old trading rules still apply: cut losses and let profits run.

slewie the pi-rat's picture

john & jane are not pirates

they don't know diddly-squat

so, they use a miniFiniMini aka an "advisor"

the advisor insures they will not get into gold and silver coinage, cash, and food

pretty cheap too!

kito's picture

A Common-Sense View Of The Stock Market............

common sense?........pshhhaw......killed off with the dodo...................both extinct due to societal "progress"..................


Monedas's picture

Let it collapse .... we're not only ready .... we're waiting and willing and wanting !               Looks like "Ebola Break Out Rally" in PMs is leaving it's incubation stage and growing some legs !                 Monedas     1929              Comedy Jihad Disclaimer:  Rally So Named For It's Curious Coincidence With The Ebola Break Out In Uganda and Western Zaire    

TrumpXVI's picture

Common sense for sure.

It dawned upon me (one with zero professional training in investing) that my Achilles Heel was not my decisions regarding what to buy, or when to buy it, but when and how to sell.  It occurred to me that my main problem was that I had no mechanism for selling fast enough.

That's when I decided that I had to get out of the equity market completely.


busted by the bailout's picture

Market orders will get you out fast.  But you might not be happy with the result.

Joebloinvestor's picture

Algos on the market making side.

Algos on the buy sell side.

Humans, who needs them?

Almost like watching "robot wars".

PWD Lover's picture

stock transfer tax = easy fix.

magpie's picture

I am actually beginning to have doubts about its merits even as a ponzi scamming that it is a propaganda tool for the European fiscal union.

Michelle's picture

Where was the PPT during the financial meltdown? Seems their most recent action since Europe went on vacation and London traders are attending the Olympics is blatantly obvious, yawn!

loveyajimbo's picture

Thank goodness Mary Shapiro is on the job... she is effective, honest and an overall great human being... Oops!  I knew I shouldn't have had that third bongload of hash-oil!

divedivedive's picture

If the little guy isn't participating in the market they can't be the source of potential profit for the HFTs. So then where does the profit come from ? Are they feeding on each other ?

I understand this is a silly comment but I wish anybody had a way of knowing the buyer and seller associated with every trade. 

John_Coltrane's picture

My guess is the suckers/counterparties are the public employee pension funds like Calpers who delegate their funds to "smart" hedgies who then get their 2 and 20% profits no matter what way the market moves.  Why do pension funds do this?  They are underfunded with real capital (i.e. they refuse to take the proper deductions from current real employee income) so they gamble to meet those 8%/annum returns and they are too imcompetent to make their own investment decisions.    Gambling is no way to make a living!  (see the Gambler's ruin problem for more details)

Neethgie's picture

Shit man bernanke's dad just died thats gotta be worth at least 100 pips eur/usd

Dr. Gonzo's picture

Remember when the innital vote on TARP 1 failed and the market sold off 1000 points in a matter of minutes? That was the people who really run this world letting their puppet politicians know that they made a big mistake not following their instructions. Next day they changed a few words in the Bill to save face and TARP 1 passed and the hostage stock market was realeased. It's much easier and quicker to do this then to assasinate the politians they sponsored who disobeyeded them. It still spooks the sheeple really bad but not as bad as murder in broad daylight. They can do this whenever they want now that the entire world is fiat and they run it. That's why I stopped investing in stocks.

jmeyer's picture

"That's why I stopped investing in stocks," said Dr. Gonzo.

Old fashioned stock investing is one of the few ways to let your money ( if there's any left ) to actually WORK for you. Buy great companies, especially US companies, with high ratings and great DIVIDEND history. Buy low when the markets are on sale and hold. Right now is NOT a good time to buy but we will have a " correction " which will put stocks ON SALE. Let the quants and the TBTF banksters gamble in the derivatives markets. THEY are going to be swimming with pirhanas and sharks. Why should you ??