We know what this huge volume of trading is about. It’s about information, not preference shocks. Information seems to need trades to percolate into prices. We just don’t understand why.
…If you ask a high speed trader about signals about liquidating dividends, they will give you a blank stare. 99% of what they do is exactly inferring information from prices — not just the level of the price but its history, the history of quotes, volumes, and other data. This is the mechanism we need to understand.
I would be so desperate as to posit a taste for trading, aka Adam Smith’s “propensity to truck and barter.” I would actually want to examine what psychological mechanisms make investment managers decide that the portfolio mix that they held one second ago is not the right mix now.
“I think of the **government** currently as using the taxes . .”
Right there, in that reification of “government” is a core problem.
Are we not observing the results of the actions of various contending interests of **motivated human beings** to control or employ the facilities that constitute government and its coercive powers for particular ends.
As happens in societies, traditional or customary means for seeking and attaining some sufficient degree of the control or employment often atrophy or are displaced; particularly after extended periods of compromises and accommodations amongst contending interests. There comes to be no dominant control, employment of the facilities is fragmented, contending for resources. Res Publica.
“I would actually want to examine what psychological mechanisms make investment managers decide that the portfolio mix that they held one second ago is not the right mix now.”
The high speed traders are often market makers, liquidity providers. Their optimal portfolio mix changes every sub-second as they infer other participants’ information from those other participants’ trades. Think of a bookie setting point spread on a football game. Every time someone new places a bet, he moves the spread to balance bets on each side. If people are placing new bets every second, then indeed it is rational, not psychological, for the bookie to update his point spread every second even if there is no apparent news about players’ injuries and other factors.
Another example would be an arbitrageur, say trading S&P 500 futures against the 500 underlying stocks. Every time the prices of the 500 stocks changes, he needs to update his fair price for the index futures (which will cause him to change his estimate of the optimal amount of S&P 500 futures to hold). Again, rational, not psychological. A generalization of this would be trading securities that are only statisically related, not functionally related. When a trader sees the price of GM change, he updates his fair price for Ford.
Price movements contain information. Prices move every second. Hence, optimal portfolio mix changes every second.