How are the stock markets working?

How are the stock markets working?

Here is a short story that was delivered to our class at the Rotterdam School of Management, when we were LEARNING (or supposed to be learning) on “How to trade and make profits”.

This gentleman was a guest lecturer and came from a leading investment bank from London. He had more than 25 years of experience in trading – both on bonds and stocks. He introduced himself working at a real high rank in his organization and having almost 120 traders reporting to him. His words and presentation style reflected his experience.

He started by saying “So you all are here to learn trading and earn enormous profits? And you expect me to tell you how to do it? Right?”

Everyone looked convinced that he will teach us something worthwhile. However, he narrated an interesting story.
I’m putting it in my own words as below:

When Stock market trading started gaining momentum in the early 1980’s, there was a huge shortage of traders. Investment firms were finding it hard to find suitable individuals to whom they can teach trading and make them earn money for the firms. Moreover, individuals were not very enthusiastic about taking up trading as a career. Those who were willing to opt for it, were the ones who failed in other streams. This created a huge shortfall of “traders” in the market. So the investment firms and brokerage houses started looking around for people who can fit into their requirements.

The search ended at the vegetable markets. Yes- the “Sabji Mandi” of UK. (Sabji Mandi = Vegetable Market)

The vegetable vendors selling vegetables and fruits were laborious & hardworking salesmen (of vegetables) and had some typical characteristics. They had a very loud voice, which is required for survival in a Sabji Mandi. If they cannot shout, they cannot attract customers to buy vegetables from their stalls. Hence, they fit the requirement quite well, as during those days, there was no electronic trading in the stock market. All they had was a designated floor area, where stock traders interacted with each other. Shameless and loud voice was the need of the hour and was required to attract traders. Another criteria that these people fulfilled was that most of them had a well built physique with a good height – again good for attracting attention. Hence, the investment companies and brokerage houses picked up these tall, well built and loud voice humans to do trading for them and earn profit for the firm.

Actually, it worked quite well. As the stock market floor area was getting packed up with more and more people joining in – these long, high and noisy traders managed to carry on the business because they could be heard easily, could attract attention with their height and could also survive the pushing and pulling of the crowded floor area (and if required, throw out the lean individual traders)

However, markets are efficient and they have been efficient since long time. As more and more such tall and noisy traders came in, the floor area was filled only by these people. Other individuals started trading through agents, which used to be these same people taking order through hand signals. Technology crept in, telephones were used. Individuals started giving orders through phone.

Unfortunately, only loud voice and tall height was not sufficient to carry on trading in the efficient market. Hence, gradually, the investment firms started replacing these vegetable vendors with some more sophisticated and bit better educated salesmen. Physique and voice was no longer a requirement, as a lean fellow weighing only 40 Kilos could get his order executed on the phone. What was required was people who could understand money and finance, and make trades accordingly. Hence, the vegetable vendors were sent back to their original posts (Sabji Mandi) and somewhat educated salesmen took their places.

Things went on well for few years, but use of computers and technology took things on a different path. As people had historical stock data, they started to get into research. Valuation methods like DCF, etc. started becoming common. So called researchers were finally making way to evaluate stocks. The educated salesmen were no longer worth the job. Hence, trading positions then went to mathematicians, physicists and economists – especially the students from maths & economics. The salesmen returned to their sales jobs of door to door selling or working at showrooms.

Finally (and at present), the computer and internet have allowed everyone free access to data and valuation methods. Every smart alec sitting at home can now trade with his online account. Mathematicians, Physicists & economists with their limited knowledge about predicting stock prices and doing valuations were no longer required. As things became more and more efficient, MBA’s and PhD candidates with years of experience were hired to do trading and identify trends. They are the ones who are trading presently, and will continue to do so until the market identifies someone more efficient.

Story Ends:

What can you conclude from the above story? For us, the batch of students, it was just another proof of “No one can make extraordinary money from the market”.
Anyways, one thing can be clearly observed – everything is ruled by randomness. No level of knowledge can make anyone a master in stock picking or investments. For the ones those who still believe they can beat the market – all the best!

Link to previous article Indian Growth story and Investments

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