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The New Abnormal: Permanently Engineered Market Volatility

If the gut-wrenching market volatility of the past few weeks has made you sick to your stomach , I have some bad news for you: violent volatility is the new normal – or more precisely, the new abnormal.

After massive market moves last week, the Dow Jones Industrial Average tumbled 419.63 points yesterday (Thursday). And, while t hat may be bad news for average investors, it's something Wall Street wants.

If you're not a day-trader, high-frequency trader, hedge-fund manager, or institutional desk trader, reading this is going to make you mad as hell. But it's something you have to know, understand, and accept if you're going to be a successful investor going forward.

The reality is that in their crusade to manufacture extraordinary personal wealth, Wall Street insiders have engineered volatility into the capital markets.

This change is permanent.

Indeed, the same dangerous volatility that destabilizes markets creates innumerable trading opportunities for Wall Street's proprietary traders. These traders feed off each other and off their banking-industry clients.

The game is simple: Wall Street creates market volatility, some of which leads to panic. Panicked investors, in desperate searches for safety, turn to "experts" for protection. And Wall Street rakes in the profits – not just from their market-crushing trades, but from the investment fees they charge individual investors, companies and nations.

It's similar to how the mafia might trash your business and then offer to "sell" you their protection services.

By increasing volatility in stock, bond, commodity and real estate markets, The Street has created a self-perpetuating moneymaking machine.

Obviously, without the manufactured volatility, markets would be more stable, predictable and better serve economic development and growth. But there are no extraordinary gains to be made in calm and stable markets.

So Wall Street for decades has worked to make market volatility the norm.

Exodus: The Beginning of Volatility for Profit

The roots of manufactured market volatility can be traced back to an obsession Wall Street has with disadvantaging the public while giving itself every advantage it can.

In 1969, Institutional Networks Corp. launched Instinet, the original off-exchange "communications network" designed for private use by institutional traders and dealers.

Instead of placing their orders and transacting on the principal exchanges where stocks traded almost exclusively, Instinet provided its members a competing venue where they could show each other bids and offers that the public wasn't privy to.

The club became so successful (I was member myself) – partly as a result of its exclusivity – that it eventually spawned competition.

In fact, it spawned a lot of competition.

What eventually became known as electronic communications networks (ECNs) proliferated in the 1990s. Eventually the multiple electronic exchanges, fashioned after Instinet and the over-the-counter (OTC) exchange that became Nasdaq, ended up competing for orders from brokers, dealers, institutions and a new breed of gunslingers known as "day traders" .

All of this competition dispersed trading to such a degree that it was difficult to know where to go to get the best price when trying to buy or sell stocks. But Wall Street eventually saw the benefit of the wide price discrepancies across multiple trading venues: It increased volatility, creating new trading opportunities.

Working (Over) the System

Of course, nobody on Wall Street believes you can ever have too much of a good thing. The first result was that big-name trading shops and old-world exchanges bought up the more profitable ECNs. Then they went on to start other private exchanges and trading conclaves known as "dark pools ."

In order to drive business to their trading venues, these synthetic exchanges pay for "order flow" and offer incentives to attract bids and offers for blocks of stocks.

The game, invisible from the surface, is designed to accomplish several things. If you control a venue that generates a lot of buying and selling, you can "internalize" the order flow. That means you don't have to trade outside your house – you match orders internally because you have so many buy and sell orders coming in. And then there are transaction fees.

If you are the "house," you can also take the other side of any trade you want, which has its advantages.

But the biggest advantage these venues have is that they "see" what orders are coming into them. And, regardless of whether or not it's legal, they trade against them and take advantage of knowing the specifics of other pending orders that can be used to backstop losses. I'll get to that is a moment.

Another piece of the market-volatility puzzle was neatly fitted with the advent of "decimalization."

Beginning in 2000, and finally encompassing all stocks on July 9, 2001, trades could take place in increments of one cent. Prior to the implementation of decimalization, stocks traded in increments of eighths. Stocks used to trade in increments of $0.125, $0.25, $0.375, $0.50 and so on. You couldn't buy or sell a stock for $50.01 or $50.05, for example. You would have to transact at $49.875, $50.00, $50.125, or $50.25.

Even though changing to one-penny increments was sold as a way to reduce spreads and transaction costs, the hidden agenda was to increase volatility.

Decimalization didn't make for more liquid markets. It simply encouraged more risk-taking. Trading and holding horizons became shorter. And institutions stopped putting down big limit orders, because traders used those orders as backstops to sell into if their speculative buying didn't work out.

Markets got "thinner" and less liquid as a result of smaller orders being put up. Instead of lowering transaction costs, decimalization increased transaction costs: It now takes a lot more trades to buy or sell large blocks. It also can take a lot more time and expose buyers and sellers to steeper price moves.

The increased number of venues combined with more risk-taking to increase volatility exponentially. It was all working.

But there was still one little problem that Wall Street wanted out of the way.

The New Abnormal

Wall Street finally got what it wanted on July 6, 2007, when the Securities and Exchange Commission (SEC) did away with the "uptick rule." As of that day, it was no longer necessary to wait for a stock to go up in price before short-selling it. Without the uptick rule, short-sellers can short any stock, at any price, at any time.

There's plenty more that Wall Street has done to ratchet up volatility. It has flooded the world with derivatives that aren't regulated, and blessed high-frequency trading. It also introduced innumerable securities and financial instruments that it can arbitrage for healthy profits against unsuspecting institutions and the public.

Not surprisingly, market volatility is now a tradable product. And now that Wall Street has taken us down this path of entrenched, institutionalized volatility, there's no going back.

Don't expect any respite from what's going on in the markets now. On the surface, it's all about Europe, debt, downgrades, earnings, fundamentals and technicals. But underneath all those prime movers are the real shakers, the greasy palms of the markets hidden hands.

Abnormal is the new "normal."

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. john ashton | August 19, 2011

    An important piece in my view. A blindly self-interested group is wreaking havoc with many 100s of thousands of peoples lives whilst enriching themselves in the process. This follows two years after this same group connived in a general market collapse that has impoverished millions across the globe. It is a mark of the dysfunctional government in the world's most important economy that not only is the behaviour ignored but appears to be condoned. It is surely time for extreme measures against this rigged structure. The end result is going to be the discrediting of the US system of capitalism. Every American citizen should surely reflect that to the outside observer what their forefathers paid for in blood and treasure; the defeat of German militarism and corrupted communism, is being undone by the soft hands of these avowed 'capitalists'. A slow motion tragedy is in train.

  2. clearVision | August 19, 2011

    VERY INFORMATIVE. The average citizen has come to realize that the Markets are MANIPULATED. Many of us are fleeing for cover, but if you have a 401k your options are limited. Limited options means you are being looted by design. Any safe haven you find will also be INFLATED away.

  3. db | August 19, 2011

    So we're hosed?

  4. Jose Palli | August 19, 2011

    More than resembling the Mafia, the volatility of the market confirms that all you guys are little more than gamblers, playing at a Casino where the rules, obviously, favor the House -Wall St.- which loves to set those rules to the disadvantage of the playing crowd and give itself as much of an advantage as it can get away with…

    It is not surprising that the House can get away with as much as it does, since it is in cahoots with those who should be looking after the interests of the playing crowd -namely those who are supposed to "represent" us in our vaunted political system- but have sold out to the interests of the House (and to their own self-interest). We even call one of our political system's dysfunctional organs "The House"…

  5. Robert Carney | August 19, 2011

    It is obvious that someone throws the switch and instant gratification for those on the right buy/sell side.
    The speed of occurance indicates the switch is programmed in advance.
    The silver crash was orchestrated by manipulating margin requirements on SLV.

  6. Angel | August 19, 2011

    Keeping it Honest: The new ECONOMIC reality, What’s Jobs got to do with it? “When the Stock Market zigs and zags itself up and down to percent losses during the past three weeks, wiping out $2.5 trillion in wealth”, it was clearly sending a message. But what, exactly, has the market been telling us? The most obvious conclusion is that it has absolutely nothing to do with creating American jobs! If market was truly concerned about the inability of the U.S. government to deal with its budget, there should have been a spike in interest rates as bond investors became more nervous about the continued flood of government debt and the increase risk that they may not get their money back. But the Wall Street Market has become nothing more than a Las Vegas casino game of winning financial profits based upon paper shuffles that is not based upon actual productivity or company growth to create new jobs to produce something!
    Therefore, the New economic and political reality is The BIG DISCONNECT! As the drama of the past few weeks has affirmed, while the national news and political pundits report that the major parties differ on how to cut the debt, it is almost impossible to find any politician on either side that is willing to endorse a big push in public investment and continued high deficits to create jobs in America. It doesn’t matter that interest rates is so low make it a superb time for the government to borrow or the fact that the bond market has made clear that it doesn’t think we’re Greece! However, the new ECONOMIC reality is the Stock Market has nothing to do with job creation! No one in Washington seems to listen including the Obstructionist in the U.S. House and the filibusters in the Senate that are more concerned with politics gamesmanship than helping Americans get back to work!

  7. eugene | August 19, 2011

    It has been apparent to me that eliminating the "up tick" rule would produce the roller coaster
    rides that we have today.
    The question is why is it not shouted by the TV financial talking heads? The answer is obvious
    to me. There is so much money being gained ( by inverstment banks, hedge funds, etc.) that
    if those talking heads would speak out against it, their jobs would be lost. If they would persist
    they may even disappear from this earth.
    Without the up tick rule Wall Street will remain "Las Vegas Worldwide".

  8. Dan | August 19, 2011

    Very well stated. Everyone now has to trade the volatiliy…. or get out. Or just invest and never look.

    The uptick rule rescision was criminal and is just one more example of how regulators and Congress are just the yellow running lap dogs of the investment bankers and their fellow travelers in the funds. And the super rich are benefitting too from being cut in to further compound their wealth – otherwise they would yelp and put a stop to it.

  9. cristhian pirazzoli | August 19, 2011

    You are ok

  10. M Fedrick | August 19, 2011

    We the gambling working class has always referred the stock market as the rich mans track, the blue collars would go to the track and the white collars would play the stock market. What amazes me is that when a news commentator states that they don't understand why the market is doing what it's doing. It's always been manipulated and the game is to buy low and sell higher or in this case it's like Vegas, the house always has the advantage, only Vegas isn't as corrupt as Wall Street. Wise up people and remember why the rich didn't go broke, they never do, they always make money. Think about it……

  11. Luutzen | August 19, 2011

    It seem to me, Wallstreet will defeat itself in the coming years.

  12. Gary S. | August 19, 2011

    To understand complicated issues like this I always turn to the elegance of poetry for comprehension. For this I turn to a corrupted version of the Boy Scout motto:

    On my honor I'll do my best
    To help myself
    And screw the rest.

    Come to think of it, this poem sounds like a perfect description of today's Darwinian Capitalism on Wall St.

  13. globepilgrim | August 19, 2011

    I invested $10k last year to hire traders in order to learn what goes on behind the scenes. This after I had been investing for 10 years since 1997. Got burned once in 2000. But not again in 2008. And now I am again in cash. The 10K was worrh it. I know now how those o Wall Street think, technical analysis is a helpfuL tool but I do not want to live a trader's life. The conclusion is if you can't beat'em join them, buy their funds at times of greatest pessimism and do not hesitate to pull the rug from under them when you think that they must think that it is time to create panic. For that I watch the world and thw economy and what it does to the human psyche like a hawk. I enjoy doing so in any case so why not make money. As a great philosopher remarked: most are the hunted, some are the hunters but I chose to be the observer (paraphrazed). I also believe if it doEsn't kill me…. And don't blame Wall Street. It is us the people who allowed the lobbying. We elect the left or the right and can't do any better. THINK how democracy can change and what price you're willing to pay. Good new investing.

    • JosephE | August 19, 2011

      Exactly my view, but I am not good at putting what I think into writing.

  14. Bruce Mattson | August 19, 2011

    What does the average markey no mind 57 yearold idiot do with his 401 k what is going to take a beating, at least it looks that way to me?

  15. Matt | August 20, 2011

    Learn to use options to take advantage of the volitility. It's not that difficult. You can protect your portfolio and profit at the same time. Get out of the box. You must trade. The days of buy and hold are over. This market decline was a great opportunity to make thousands of percent returns on simple DIA or SPY put options. Stop complaining and embrace the huge profits available in this enviornment. Your attitude is what is killing your portfolio.

  16. FW DANBY | August 20, 2011

    Running this up the flagpole – looking for some salutes:
    We need stability.
    That means neutralizing the destabilizers.
    How about an immediate 105% tax on all profits gained by high frequency trading?
    Definition to be worked out. Hold for more than one second, one minute, one hour, one day – to be OK.
    We already tax long vs. short term holds differently.
    Why not an ultrashort hold tax? USHT. Pronounce it as you wish.
    These thieves are shouting "Fire" in a crowded theatre, causing panic.
    What is worse, there is either no fire or they are setting the fires themselves.
    I have written MY congressman. Please send this to yours.

  17. Ron S | August 20, 2011

    There is a lot of money in pensions, 401k's and retirement accounts in which long term investors do not want to be part of high sped trading, even if it could be on a relatively cheap computer some time in the future. Eventually, probably sooner than later, mutual funds will set up a competitive alternative for the general public. After all, there is still money in the hands of average people that will need this service. They will charge (front loaded funds) for the service but we will be desperate to join.

  18. Susan B. | August 20, 2011

    I can only hope that Luutzen's comment "Wallstreet will defeat itself in the coming years." comes true. Things have gotten so far out of whack from the banks, Wall Street, big companies, and the politicians.

    We have certainly let it get this bad ourselves. It is time to do something about it, but what? I am afraid things are going to get much worse before they get better. We are in need of a major reset, so the whole big mess is going to have to completely collapse before action is taken in the right direction.

    I have suspected this sort of market manipulation, and I am happy to see it brought out into the open. How many people need to know about this before something is done? There are a lot more of us than them.

  19. gordo brown | August 21, 2011

    i am a canadian investor who knows very little of the stock market. i invest in mainly commoities that i think are good bets and i hold them till they make a profit. i have micomet [miti], tolow oil [tuwoy] a canada silver stock and i am really worried about the american dollar.

  20. | August 21, 2011

    OK Let me jump right in with a very contrarian view as most people have not studied their history very well.

    I am on the wrong computer or I would just show you the charts from 1900 forward and they show that the market works in roughly 20 year cycles give or take 5 years but go to this link and you will see what I mean|p1

    If that link is not clickable cut and paste it into your browser.

    In my opinion the worst thing anyone can think is that it is somehow different this time, for then you have no guidelines. Follow the smart money, the Insiders. they have to tell you when they are buying and selling and interestingly they are usually selling when the amateurs are buying and buying when there is blood and fear in the street. Same old same old!

    So I am just not buying the conspiracy theory. The insiders are just making money same as always, by really knowing what is happening and not trying to squeeze the last dollar out of every position. Sounds like the same old fear and greed. Too scared to get in when the prices are low ( you remember the axiom, Buy Low and too greedy to get out before the market crashes, remember the other axiom: Sell High

    Ms. Market has acted just like 1929-1932 so far, despite all the meddling.

    Study your history. Particularly your long ago history. Ms Market is not stupid enough to do this market drop like 2008, that would be way too obvious.


  21. mostafa | August 23, 2011

    I think all of these events happens for clearing america's debt. America should to pay 14trillion$ debt so the gold prices go up and up and stock prices down and down.

  22. RICHARD KEESAN | September 23, 2011

    Please e-mail me from Private Briefing Martin's dividend stock report and his favorite dividend stock with 9.15% yield as well as other exclusive picks from your financial experts. This was in your August 19th Money Morning and we joined the Private Briefing service for this report.

    Thank yyou,
    Richard Keesan

  23. Steve | September 28, 2011

    Thanks Shah for your wisdom; I always listen to you. I fully appreciate Matt's comment of August 20th. He is right, but I cannot help but feel that today's market math is attitude + timing = yield. The math of modern investment strategy has changed from attitude + time = investment growth.

  24. R. Squier Ball | October 15, 2011

    Fiscal shenanigans have long been part of the general American and world scene. What is new is that US financial stability is now a question. In whose interest is this new instability? Could it be due to stupidity, greed or planned chaos? Each possibility should be faced, and thoroughly researched. Failure to pursue each possibility would indicate a lack of mental courage, moral courage or complicity. Or maybe a mix of all three.
    What your offerings have brought out, besides "lack of knowledge", and the usual capitalist greed, is the possibility that some participants in volatility games may know very well what they are doing.
    Long story short: the "third rail" of present day financial discourse is power groups, half public and half government. To begin, there are: the Council on Foreign Relations(CFR), the Bilderbergers and the Tri-Lateral Commission. Will we ever see a public discussion of these groups? If not, will we be fellow-travelers in a vast exercise in mind control?

  25. Nelson Merritt | December 28, 2011

    The change in Wall Street volatility does not have to be permanent; it can be fixed overnight. Believe me!

  26. Nelson Merritt | December 28, 2011

    Shah has an unbelievable understanding of the market mechanisms and can describe them as no one else can. I, for one, would nominate him for the Nobel prize.

  27. frank | February 11, 2016

    There's certainly a lot to know about this issue.
    I really like all the points you made.

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