Traders and Government Rumors Dominate the Week

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Dramatic volatility characterized the equity markets again for the ninth straight week. One hundred or multi-hundred-point moves in the Dow Jones Industrial Average took place every day this week–on most days in both directions. On balance, most stock indexes gained about 2% for the week.

To anybody watching the markets carefully, it is apparent that large short-term trading interests have come to dominate the action. Today’s price movement was a perfect example. Heading into the end of the day, the market was progressing quietly until traders took over, pushing the Dow up by 115 points in about 50 minutes, with volume swelling as prices reached their peak. Then it was time to take profits, and traders pushed prices down by almost 130 points in the last half hour on the biggest volume of the day. Clearly this wasn’t the action of investors. There is nothing inherently wrong with trading, but there is a danger to markets if investors feel threatened by apparently unexplained volatility. According to insiders, the large high frequency trading operations now account for roughly half of New York Stock Exchange volume and clearly accentuate price moves in both directions. While such activity provides significant revenue to the exchanges, it may undermine their long-term profitability by chasing away real investors, who are understandably withdrawing from what increasingly looks like a casino.

Over the past two months traders are taking their cues from headlines, most of which revolve around the expanding European debt crisis. This week they followed the script to a T. Going into the last hour Tuesday, prices on the Dow were down by nearly 500 points for the week. A report out of Europe sufficiently excited traders that they then pushed the Dow up by almost 400 points in less than an hour. What was that momentous report? European financial officials were going to “talk” about recapitalizing European banks. They hadn’t agreed to anything substantive. They merely indicated that they would talk about something that, almost certainly, they have been talking about for months. These price moves are not coming from long term investors but from traders playing with rumors.

Such frenetic activity is not likely to end soon. New rumors emerge from Europe each week as the fundamental condition worsens. There is no easy answer to the overwhelming debt problem, and to get unanimous agreement from nations with very different financial and cultural makeups will prove extremely difficult at best.