Lessons From The Recent Trading Craze

No great mind has ever existed without a touch of madness. Aristotle

Aristotle had a good point:  Without a touch of madness, we would all be secure in our consensus thinking and that's not helpful for innovation. Often, it's the seemingly crazy question that leads to new ideas and fresh ways of tackling old problems. For a long time, algorithm developers have been able to examine individual transactions, volume, and price levels and estimate how much volume is long and short at various points in the market. At key points, these programs can push prices beyond a pain point, forcing shorts to cover and longs to scramble from their positions  Figuring out where buyers can't push prices higher and sellers cannot move markets lower is a durable source of edge, in part because market participants tend to be leveraged and cannot take heat on their positions.  

So along comes a touch of madness saying that this same dynamic could be implemented by large groups of traders aligned in social networks. Some large market players specialize in short-selling strategies, seeking to profit when individual stocks are overpriced. They then leverage bets that these high flyers will return to earth. But what happens when networks of individual traders take the other side of that bet, pushing prices higher than the short sellers can bear?  The result is that overbought stocks become insanely overbought, but over the short time frame the inability to take heat has created yet another trading edge.

You don't have to be a whale to dominate the seas. Piranha in sufficient numbers can take down the largest creatures. It just takes the madness of a few lead piranha to see what can be possible.

Ultimately, markets will absorb the participation of trader networks as they have absorbed the participation of computers: through regulation and oversight.  But I'm not sure the genie gets back in the bottle once unleashed. Networks are likely to be here for good, introducing elements of madness in politics and finance, sometimes for better, sometime for worse.

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