How technological change has affected the markets…

How technological change has affected the markets…

In recent months we have been able to explore some of the strategies and systems deployed by professional traders…

For example, we took our look at both value and growth styles of investing.

And we’ve touched on key relationships within the markets. For example, the effect currency fluctuations can have on earnings expectations for exporters and indices, such as the FTSE 100, Dax 30 and Nikkei 225, which are full of overseas earners.

We have also looked at items such as market structure and breadth, specifically the idea that for a healthy market we want to see a broad range of stocks participating in a trend – whether it be upward or downward – rather than just a narrow group of stocks making the running.

By the same token we have looked at how the S&P 500 is seen as proxy for global equities and today is the preferred measure of US equity performance, rather than narrower and more often quoted Dow Jones Index, which has just 30 constituents.

I have often said that each day in the market is a learning curve and even after 30 years that is still proving to be true…

Only this week I found out why the Dow 30 has retained its appeal to and place in the mind of US investors.

We have to travel back in time to the 1950s and the age before computers and instantaneous pricing and calculation to find the reason…

At that time the prices of the individual Dow stocks were distributed via a ticker tape on an hourly basis and traders who wanted to know what effect price changes had had on the underlying index had to do the math for themselves (i.e. work out what an individual stock move was worth in index points and then tally those figures to create the index change and value).

Just imagine doing up to thirty relatively complicated multiplication and divisions and a final totalisation every hour, just to discover whether the market was heading higher or lower and by how much.

The forerunner of S&P 500 index was introduced in the 1950s but traders largely ignored the new benchmark, simply because no one in their right mind would try to take on 500 calculations to determine the index change.

So it was the Dow that traders referenced on and hourly and daily basis, simply because they could (with some considerable effort) quantify the price action of 30 stocks, but not 500.

Prior to 1984 the benchmark index for UK equities was the FT30 and no doubt that was in place for similar reasons.

Just think about the effort traders and investors had to go through to discover what we would now consider to be basic information – and then be thankful that we live in a connected computer age.

That connectivity has brought new challenges and new relationships as the world moved online and international trade grew as a function of globalisation.

[It’s also enabled the rise of alternative, digital forms of investing and trading, and types of instrument you can trade for a profit… like the crypto-currency boom of the past decade, which are making many savvy traders a fortune (find out how here).]

Capital flows round the world more freely, which has enabled or created new trading strategies or behaviours and made investor sentiment a global barometer, rather than a regional one.

A prime example of this is concept of “Risk On, Risk Off”. As the mood of the market changes so does its appetite for certain instruments.

In “Risk On” periods it is equities (often in high growth sectors and geographies) and emerging market currencies that are sought after.

But in “Risk Off” mode those instruments are sold in favour of safe havens, such as government bonds from the USA, Germany and the UK, and safe haven currencies, such as the Dollar, the Euro and the Yen.

If investors choose to stay in equities during these periods, they will typically buy defensive stocks and sectors such as utilities and consumer staples – dull, staid stocks which are seen as stores of value and, because of which, are often described as “bond proxies”.

One of the other recurring themes we have looked at is investor behaviour, often characterised as sentiment. Trying to judge the mood and directional bias amongst investors is a modern traders primary task.

Over 2017 to date the mood has been largely bullish, with only infrequent and very short-term swings towards negativity.

The reason behind that bullish sentiment has been quantitative easing which, as we have previously noted, has been at its most aggressive at any time over the last eight years during 2017.

The transition away from that and back to normality, the form it will take, and the effect it will have on the markets is one of our current “known unknowns”.

But that’s what makes trading and writing about it so exciting because you never really know what’s coming next…