The recent incident where the Syrian Electronic Army (SEA) hacked AP’s Twitter account and posted fake tweets reporting explosions in the White House and the injury of President Barack Obama, leading to a 1 per cent fall in US financial markets, points to the fact that shrewd manipulators, aided by technology, can ‘manufacture’ news and make gains from the market’s inability to immediately ascertain if a piece of news is authentic or fraudulent.
There can be many reasons why the financial market is inherently weak when it comes to countering such vulnerabilities. For one, the market is not known to be god at ascertaining truth. On the other hand, it has immense faith in the wisdom of the majority. Therefore, if the majority reacts to a piece of news in a certain way, irrespective of whether it is valid or faked, then their perspective, or the lack of it, is seen as the market’s perspective. The reason is simple: for most investors it is easy to ‘follow the herd’ than spending time and effort to ascertain the veracity of news and information when it comes to making investment decisions. Legendary investor Benjamin Graham and his more illustrious disciple Warren Buffett have warned against the herd mentality which has over and over again proved to be a real chink in armor of even those investors who claimed to be systematic and disciplined. But why most investors tend to be part of the herd and react to a piece of news or event irrationally despite possibly knowing that it is not the right thing to do?
The efficient market theory says that the decisions of the well-informed buyers and sellers lead to fair prices. But if the theory is true, then stocks are always fairly priced and it makes as much sense to by them when they are trading at 30 times their earnings as when they are trading at three times. Obviously there are some gaps in the theory. Behavioral finance tends to offer a clue as to why humans possess ample traits that prevent rational stock market behavior and prominent among these traits are greed and fear (existence of casinos means humans are not rational about money), vanity (this forces investors to hold on to their picks even when stocks keep going down) and an unfounded respect for the majority’s whims (most investors believe the market, or herd, is always right while the truth may be other way around).
Stock prices are nothing but the present value of expected future earnings and the present has already been discounted by the market six or 12 months ago. This points to a certain correlation between an event and the time the market takes to react to it. Therefore, if a technologically innovative market manipulator, using a fast algorithm, can get insights into emerging events before others; hack into news sources, and post flashes that can potentially push the market up or pull it down; he/she can make gains during the intervening time when the market—which is nothing but the collective wisdom of the majority—tries to figure out the veracity of the information.
There can be many reasons why the financial market is inherently weak when it comes to countering such vulnerabilities. For one, the market is not known to be god at ascertaining truth. On the other hand, it has immense faith in the wisdom of the majority. Therefore, if the majority reacts to a piece of news in a certain way, irrespective of whether it is valid or faked, then their perspective, or the lack of it, is seen as the market’s perspective. The reason is simple: for most investors it is easy to ‘follow the herd’ than spending time and effort to ascertain the veracity of news and information when it comes to making investment decisions. Legendary investor Benjamin Graham and his more illustrious disciple Warren Buffett have warned against the herd mentality which has over and over again proved to be a real chink in armor of even those investors who claimed to be systematic and disciplined. But why most investors tend to be part of the herd and react to a piece of news or event irrationally despite possibly knowing that it is not the right thing to do?
The efficient market theory says that the decisions of the well-informed buyers and sellers lead to fair prices. But if the theory is true, then stocks are always fairly priced and it makes as much sense to by them when they are trading at 30 times their earnings as when they are trading at three times. Obviously there are some gaps in the theory. Behavioral finance tends to offer a clue as to why humans possess ample traits that prevent rational stock market behavior and prominent among these traits are greed and fear (existence of casinos means humans are not rational about money), vanity (this forces investors to hold on to their picks even when stocks keep going down) and an unfounded respect for the majority’s whims (most investors believe the market, or herd, is always right while the truth may be other way around).
Stock prices are nothing but the present value of expected future earnings and the present has already been discounted by the market six or 12 months ago. This points to a certain correlation between an event and the time the market takes to react to it. Therefore, if a technologically innovative market manipulator, using a fast algorithm, can get insights into emerging events before others; hack into news sources, and post flashes that can potentially push the market up or pull it down; he/she can make gains during the intervening time when the market—which is nothing but the collective wisdom of the majority—tries to figure out the veracity of the information.
No comments:
Post a Comment