The Stock Market & Liquidity Theory

Not entirely SEO related, but the stock market is another information system which is often manipulated.

Not that I have much money, but recently I read a book called Trim Tabs Investing by Charles Biderman. On a macroeconomic level it looks at the stock market in terms of volume of shares, their overall price, and the money chasing those shares. Rather than stating that forward earnings drive the stock market they believe the short term stock price can best be described using supply and demand.

It breaks down the money chasing the shares into the following groups:

  • insider and corporate trading (smart money)

  • general investor trading (dumb money)
  • foreign investor trading (dumb money)
  • margin debt (dumb money)

In the short term the money from the typical investor can power the direction of the stock market, but the stock market inevitably goes in the direction of the insider and corporate trading. Peaks in the stock market (tops and bottoms) are often associated with rapid changes in margin debt.

People are emotionally attached to their investments, and tend to believe the future actions of the stock market will follow the recent past. People take out loans to be fully exposed to the market near tops. People also lose hope and cash out at a loss near bottoms. Foreign investment is also another lagging contrary indicator.

Insiders have access to better data, and their actions are thus inclined to be more representative of actual market conditions. Their ability to control the float (number of shares on the market) gives them an unfair advantage. Also sometimes they will forcast a lack of guidance while the stock market is doing bad so they can actively rebuy their own shares for prices below their actual value.

I thought it was a pretty cool book. For small investors he still recommends just dollar cost averaging or using buy and hold, but for those who are rich (some of the early SEO gods are probably sitting out mounds and mounds of cash right now, as early Google workers likely are too - hi Matt) and seek larger gains, liquidity theory may help them do well in both good and bad market periods.

Published: May 22, 2005 by Aaron Wall in book reviews


March 2, 2007 - 11:06am

I've noted tha the author claims to have altruistic motives and does present some new ideas, which likely work. Unfortunately, it is difficult to collect all the data by oneself. The subscription service is expensive. If Mr.Biderman is truly altruistic, he will keep his subscription cost low.

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