The stock market casino

One institution that has significant amounts of mythology and lore surrounding it operation is the US stock market. Wall Street has made many a man wealthy. These wealth generating stories are legends. What no one really talks about is about those who lose money and are often bankrupted by the same institution. In a prior post, Baseball cards as equities, I give a brief analogy describing stock trading as an ongoing auction. What is important is stocks have no value except what an individual is willing to pay and in the end, it is a zero-sum game.

As the market has been plunging over the last week and a half, it caught me by surprise on Tuesday with a sudden drop. That is the nature of the casino. I am guessing most stock owners are in a bloodbath at the moment. This gives me a chance to outline three kinds of investors on Wall Street.

Investor #1, The Insider
The insiders are professionals who either play stocks/bonds as a profession or are extremely wealthy individuals who have the inside track to corporate America. This group is the smallest consisting (guessing here) of at 0.1 % or 1 in 1000 investors. I guess they own 15-20 % of all stocks and bonds though. This group will always make money in the end because they have the knowledge and power to manipulate individual stocks. Insiders know when a big time news event is going to happen even before a public announcement. One fictional character who fits this category is Gordon Gecko in the 1987 movie Wall Street. The majority of all profits reside in this elite group. We define this group as those who know what is occurring.

Investor #2, Experienced, Successful Traders
This group of traders do not have the inside track as The Insiders do, but they have an idea of how Wall Street works. This group consists of smart hedge funds, individual traders and those at big bank trading groups. They consist of about 10 % of all investors. They probably have 15-20 % share in total assets. This group makes money most of the time. Since they lack advanced insider knowledge, they also lose on many trades. One subcategory of this group are high frequency traders (HFT). This subgroup uses high speed supercomputers to beat the market. What is even more interesting, HFT represent ~80 % of all trades made on the New York Stock Exchange. HFT are what control the majority of stock movement in modern stock exchanges. We define this group as those who know that they do know what is occurring.

The initial two groups outlined above are known as the smart money. They make money off of stocks and bonds. Who do they make money from? The following group, the dumb money.

Investor #3 Retail Investors and Inexperienced Traders
This group of traders represents the majority of investors. It includes all of those who put money into mutual funds, 401ks, IRAs, day traders (yes, day traders) and the majority of part time traders. This largest group of investors is fed the normal "fundamentals" and "over the long run stocks are the best investment" advice. Unfortunately, this is not the case because the stock market does crash. Crashes wipe out a significant amount invested in this group. As I previously stated, stocks are worth only what someone is willing to pay and they do not have an intrinsic value. The "fundamentals" advice is just smoke and mirrors to convince the average Joe to invest. Smart money knows these stock truths and avoid crashes. The lost dumb money proceeds ends up going to the smart money. We define this clueless group as those who don't know that they don't know.

You must be this size to ride......

The title of this blog usually refers to roller coaster rides and riders having a minimum height requirement. Recently, this has been taken to the next level at the new Universal Studios' Harry Potter themed park in Orlando, FL. Potential riders were turned away from the 'Wizarding World's' ride because their girth was too much for the safety restraints to secure them. This Yahoo! post exclaims the predicament.

Most people remember the feeling of not being tall enough to ride an amusement park ride, but some would-be riders of the signature attraction at Universal Studios' new "Wizarding World of Harry Potter" theme park in Orlando are being turned away because of their girth. The ride, "Harry Potter and the Forbidden Journey," employs individual restraints to keep each guest tucked in to his or her seat, but the restraints aren't large enough to accommodate heavier riders.

The article goes on to state a growing problem in the US, people are becoming significantly overweight (quote link does not work).

That's all fine and good, but considering the average weight of an American man is 191 pounds (and rising: in 1960 it was 166 pounds), "Harry Potter and the Forbidden Journey" could be turning away quite a few potential revelers.

I am not going to make an outright political statement here, but I am going to make a cultural critique. This effect is not limited to the US anymore just to point out the problem's extent. Everyone argues why the world is getting larger, I have a theory below.

We as Americans are getting larger due to two main reasons, lack of exercise and diet. The lack of exercise makes a person unhealthy. Before the exercise craze of the 1980's, most adult Americans did not exercise significantly. In the past average Americans were not the healthiest around, but at least the majority were not overweight. This leaves one last culprit, poor diet. I truly believe what is packing on the pounds is an overload of sugars in the diet. The easiest sugar sources to remove would be soft drinks and snacks. Even if one accomplishes that goal, the amount of sugar found in food sources such as cereals and other processed foods are enormous. Go to a supermarket and look at the amount of sugar in "healthy" cereals? Most tend to have a minimum of 19 grams per cup and the second ingredient on the box is sugar!! Multiply this amount through most of the foods we eat. Sugar has little nutritional value and creates body fat if a significant amount is consumed. Excessive amounts of consumed sugar is the problem.

The international sport

Beginning about a week and a half ago, one of the world's largest sporting events kicked off in South Africa, the 2010 FIFA World Cup. Soccer (football in most of the world) is the most played sport in the world. Personally, I do not like to watch it or play it. Not being a fan makes me wonder why is soccer universally loved? This post is dedicated to a theory on why soccer is the international sport.


Issue #1: Entertainment

For people to play a sport and continue a sporting tradition, the sport has to be entertaining. No one is going to play a boring sport. No one is going to watch a boring sport. What may be fun for one person, may be drudgery for another. This is universal to all competition. What is required in a sport's continuation generation to generation is mass entertainment appeal for both participants and those watching a sporting event.



Issue #2: Cultural adoption

Adopting a sport requires the game not to offend the native culture or religion. Another point that would make a sport's rejection would be the sport reminds a group of a rival, conquering tribe/nation.



Issue #3: Nonviolent action

It can be said that violent sports permeate the world. Their appeal tends to be limited though due to the destructive nature on participants. It is much preferable to play a sport that allows one to live a long, healthy life and even participate in one's later years in comparison to a senior broken body.



Issue #4: Accessibility for the masses

The majority of professional athletes in the major sports do not come from wealthy families. It is difficult to gather enough athletes for a successful league using only well-to-do athletes. Wealthy classes do not push chidren towards professional sports. Building a large fan base would also be difficult without the majority of average citizens. The classic sport that fits this category is skiing. The game has to be simple and be accessible to even the poorest children to be universally adopted.

Looking at the major sports limited to a few countries, here is where they fail to meet the criteria above.

Archery and shooting sports - Not entertaining, lacks accessibility since bows/arrows and firearms cost quite a bit.

Baseball - Need a glove, bat and ball to play. Baseball requires significant sized field. Inaccessible to the poor. Of the major American sports, this is the most international.

Cricket - Same as baseball except British. It has the further disadvantage of being complex.

American football - Violent

Running - Not entertaining for the masses

Golf - Extremely expensive sport requiring a course, thus, inaccessible to the poor.

Tennis - Tennis is similar to golf.

Basketball - The only disadvantage basketball has is the requirement of a hoop on a court. It has the potential to become universal sport over time.

Soccer fits all of the criteria above. Soccer only requires a ball and very little space to play. The rules are extremely simple. It also had the further advantage of being spread through the late British empire at the end of the 19th Century.

Vader in psychotherapy

This Yahoo! posting is funny. Darth Vader was analyzed for psychological disorders by a group of French researchers. This strikes me as being strange, because are we American's culturally inferior (according to the French) to Europeans? It appears they respect good American movies though. Moving on to subject at hand.

After analysis of Lord Vader's behavior in the six Star Wars episodes, their conclusion was Vader has borderline personality disorder (BPD). Their diagnosis of the Sith,

His enemies and underlings are painfully aware that Darth Vader is highly irritable and prone to bursts of anger. But until now, we don't think anybody knew that the Dark Lord of the Sith may have suffered from borderline personality disorder.

According to a popular blog over at CNN, French researchers have concluded that Mr. Vader (aka Anakin Skywalker) has, at various times, exhibited six of the nine criteria for borderline personality disorder. To be diagnosed with BPD, you need only showcase five of the behaviors.

They go onto address his unstable relationships with his son, wife and other family members. One may ask, what is BPD? Wikipedia defines it as in the link above (links do not work in quote below),

Borderline personality disorder (BPD) is a personality disorder defined in DSM-IV and described as a prolonged disturbance of personality function in a person (generally over the age of eighteen years, although it is also found in adolescents), characterized by depth and variability of moods.^[1] The disorder typically involves unusual levels of instability in mood; black and white thinking, or splitting; chaotic and unstable interpersonal relationships, self-image, identity, and behavior; as well as a disturbance in the individual's sense of self. In extreme cases, this disturbance in the sense of self can lead to periods of dissociation.^[2]

I am glad the French are doing cutting edge research. At least, it is entertaining.

The wave of pain

In previous posts, I gave a brief outline of Elliot Wave principle and how it pertains to investor psychology in stock markets (click here and here for the postings). I also spoke about the sovereign debt crisis in Greece along with the problems of the PIIGS. This post will bring together these two concepts and what is currently happening on the US stock exchanges.

Today was a massacre. The three major indexes (Dow, NASDAQ and S&P 500) all fell more than 3%. One major factor roiling the market is the continued debt crisis in Europe. Even after ~$1 trillion USD bail out a few weeks ago from the European Central Bank (ECB) and the International Monetary Fund (IMF), the European Union (EU) is still not economically stable. More debt does not solve Europe's fundemental marcroeconomic issues. The country that is the focus of attention is Hungary. Hungary is not part of the EU, but the former communist block country received significant amounts of loans from EU based banks. Hungary is threatening to default and the potential massive losses to those EU banks are both enormous and destablizing. The jobs report for May also came out worst than expected. These events contribute to the main stream media's story to why the market sell off occured.

Was this sell off predictable? It is impossible to determine the exact movement or level of the stock market on any given day. Anyone who says they can is a liar or an insider. Insiders can only predict with a certain stock for limited amounts of time (insider trading is illegal). For us average folk, it is possible to approximate the direction and pattern a market may take using Elliot Wave principle (EW) which is a technical analysis method based on the Dow Theory. EW prescribes potential outcomes. The EW community tends to believe we are in Primary wave 3 of a secular bear market. We are a heavily indebted society with a debt bubble that needs bursting. Accordingly, I believe we are at this stage in the bear market as of today:

Cycle 3 of 5 (Primary wave 3)
Intermediate 1 of 5
Minor 3 of 5
Minute 3 of 5

Remember, each wave is further divided into 5 subwaves in the repetitious fractal form. The minor 3 of 5 represents the largest 3rd wave of a fractal. I was skeptical about any waves smaller than the minors, but the last couple of weeks made me a believer. The 3rd wave is also the most violent in action. The sell off today represents the sudden movement expected in this bear market stage.

The answer for the predictability question is yes. The massive sell off was predictable being limited to approximate dates and amplitudes. I was prepared by going long on inverse ETFs or funds that respond in an inverse manner to the market movement (represented stocks go down, fund goes up). This current downturn should continue on for a least a few more trading days.