Why are stocks so volatile?
The unpredictability and wild up and down surges of the markets stem in part from the low volume of trading. Ashley Milne-Tyte reports on how volume affects market volatility.
A trader reacts to bad news on the floor of the New York Stock Exchange. (Timothy A. Clary/AFP/Getty Images)
More on The Economy, Wall Street, America's Financial Crisis, The Marketplace Decoder
TEXT OF STORY
Kai Ryssdal: Listen, here's what I think we ought to do. Only open the New York Stock Exchange from 3 (p.m.) to 4 (p.m.) Eastern time. Once again today the last hour was decisive. The Dow Industrials picked up almost 700 points in the final 60 minutes of trading today.
We used to be able to end this broadcast by saying the Dow was up or down half a percent, or maybe a whole percent on an especially crazy day. In fact every day this month but two, the Dow has seen triple-digit moves up or down. And investor jitters aren't the only reason for what the experts like to call volatility. From New York, Ashley Milne-Tyte has today's installment of our explainer series the Marketplace Decoder.
Ashley Milne-Tyte: Let's go to another kind of market.
Man: 'Ere we go! Bit o' top quality 'ere now.
Back in my hometown of London, purveyors of fruit and veg do everything they can to out shout each other as they fight for customers. That keeps prices low. Art Hogan is chief market analyst at Jefferies and Company. He says say you went to a local market and wanted to buy apples.
Art Hogan: If you have, you know, 25 or 30 farmers standing there the price is gonna be in a pretty tight range. Because there's gonna be a lot of offerings and there's competition.
He's talking about trading volume. The number of apples that are bought and sold. Reduce the number of farmers by half, he says, and there'll be a far narrower range of apple prices. Which means customers are less likely to get a good deal.
Hogan: That's exactly what happens in the stock market. The more participants you have, the higher the volume is, the less volatility you have. And the fewer participants you have, the fewer buyers and sellers that would minimize changes in price, the more volatility you're gonna have.
The stock market's volatile now because loads of investors have pulled out. So there are far fewer shares to trade. And fewer people to buy or sell. So when trades do happen they can cause much bigger moves in stock prices than usual. Trader Mike McCarthy knows what that feels like. He says on a normal day he can buy or sell a hundred thousand shares of a particular stock in a tight range.
Mike McCarthy: Down a dime, down $0.15 or something like that. And now in this more volatile time you'll get that same order, sell a hundred thousand shares of something, and you'll find yourself knocking the stock down, you know, a dollar or two.
It goes the other way too, and just as dramatically. Just look at what happened today.
In New York, I'm Ashley Milne-Tyte for Marketplace.
Comments
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From Southport, ME, 12/01/2008
There is a tendency of the pindits to still talk about the sentiments of the "investors" driving the market one way or the other.I suspect that "investors" , at least individuals, are sitting on the sidelines right now, too scared to move one way ot the other. What you have left is "traders" who do not buy or sell baised on value, growth or income, since they don't expect to hold any position more than a few days, but only hope to make a point or two on the swings. Isn't that the motive behind bulk trades,ie:simultaneously buying or selling a dozen or more stocks. Bulk trades make up a huge portion of the total NYSE volume. If there is no sentiment for shutting down most short trading as a market manipuilating device, , why not increase the income tax on the sale of stocks held less that two weeks and reduce the long term capital gains tax shortening the holding period to three months. That should calm things down.
From Beltsville, MD, 11/21/2008
Mike,
You are right for the most part, but you are leaving out some very important factors. The underlying reason that stocks are volatile is that they are a vehicle for income and not an investment. I remember someone saying that this is the age of investment banking. Meaning that is how, where you make money. Oil went to from 60-70 to what and then back down to 50? I'm sorry, but that isn't demand. That is pure speculation. Investment banks have been spanked, and therefore there is less money racketeering and over inflated prices.
From Hudson, WI, 11/18/2008
The volatility is the result of less long term investment demand. Long term investors, those who base their demand on future revenues and profitability create a stable market. those who invest on the speculation that a stock price will change and attempt to profit on that change create volatility as they affect real time demand and therefore real time price. As most homeowners have substantial credit obligations long term revenues are facing a double whammy. Recently revenues have grown due to household credit which increased household supply of money. That is now gone and must be paid. Long term investment demand is likely at an all time low leaving speculative buying and long term selling.
11/06/2008
It would appear that somewhat more of the volatility can be attributed to institutional investors rather than indivudual investors. [Cf. Yale School of Management Stock Market Confidence Indexes]. If, as seems likely, institutional investors are more cognizant of each others' sentiments than indivudual investors are, then it's more likely that institutional investors will exhibit herd behavior and produce greater swings in behavior.
10/29/2008
Ashley Milne-Tyte did not ask whether the short selling ban has affected volume and, thus, impacted on volatility. It would appear that limiting trades will affect volume and thus increase volatility. You can even buy or sell it on the CBOE (see VIX).
Ashley gets the equation wrong in her piece. She states: "He's talking about trading volume. The number of apples that are bought and sold. Reduce the number of farmers by half, he says, and there'll be a far narrower range of apple prices." This can't be right.
If you reduce the number sold, you will reduce the volume but not the range of prices (volatility). The more buyers and sellers in a marketplace, the narrower the "spread" between the bid (offer to buy) and the ask (the offer to sell). Competition should drive the spread to be narrower, not wider.
From Los Angeles, CA, 10/28/2008
Tom,
Songs from each day's show are posted in the right rail (scroll down a bit and you'll see it.) They're also listed on each show's main page.
-- Richard, Marketplace website editor
From MD, 10/28/2008
I love the music you play between stories. Where can I find a listing of these songs?
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