6 ms·

After the sell-off, there’s a lot of cash (yes even more) washing around right? It has to go somewhere, and so it will come back into securities in probably a f

After the sell-off, there’s a lot of cash (yes even more) washing around right? It has to go somewhere, and so it will come back into securities in probably a few weeks or max, months. The value represented isn’t exactly disappearing it’s still in the ‘system’. So why is a crash in equities prices such a big deal?

fractionalhare 6y ago
It depends. If a hedge fund went bankrupt, the cash will go to investors who may be risk averse. If the hedge fund survives it will have significant losses and probably be cagey about deploying a lot of capital again too quickly because it just stared into the face of death. In the case of individual investors selling off everything, they might be scared because everything is crashing. There's no rule that says the money will come back to the market quickly. It depends on investor sentiment. Often things have a V-shaped recovery and things are more or less "fine". We had a few of those over the past few years. But put it to you this way, if this statement of yours: It has to go somewhere, and so it will come back into securities in probably a few weeks or max, months. The value represented isn’t exactly disappearing it’s still in the ‘system’. ...was correct, then we wouldn't have crashes. But we do. When fear takes over the money doesn't just come back into the market quickly. And then even if it could, it doesn't because second order effects take over. Small businesses close en masse, etc, which magnifies the downturn until it snowballs into a legitimate recession. I'm not saying a crash will happen because of this. I'm saying it very realistically can happen.
- smaddox 6y ago
  There's also leverage/margin (i.e. borrowing to buy stocks). With higher volatility, investors might be less willing to use leverage, resulting in less total demand, which results in lower prices. When stocks drop, excess income and capitol drops, reducing demand in the wider market. Companies come under pressure to cut costs, and end up doing layoffs. This further lowers demand, resulting in a feedback loop. This is all described by Minsky's financial instability-hypothesis. And Steve Keen has built fully dynamic mathematical models that exhibit the process.
  - codeisawesome 6y ago
    Okay - that begins to explain the problem a bit. So people being afraid and just holding on to their newfound gains in just cash or say, T-bills - can depress the entire economy by a lack of interest in stocks. Structurally it seems a little problematic though that companies would depend so much on issuing stock to fund their operations or even growth - ideally they should be able to do that with revenue (or even debt)...
- adolph 6y ago
  Alt hypothesis: Retail just learned a method of turning tables. Hedges will temper market moving short positions due to increased risk. Overall it’s a rebalance due to innovation.
  - adolph 6y ago
    Alt alt hypothesis: smart hedges realized the overexposure while ago and wsb is schooling the dumb hedges who filled the vacuum. https://www.institutionalinvestor.com/article/b1q3cxqlbmltyl/The-World-s-Biggest-Short-Selling-Hedge-Fund-Is-Scaling-Back https://www.institutionalinvestor.com/article/b1q3cxqlbmltyl...
wrycoder 6y ago
It only becomes a big deal when the government steps in to "assist" in any way beyond providing copious liquidity. Downdrafts and even crashes are called corrections for a reason. They eliminate the weak holders and cause the remainder to carefully evaluate their positions. In the absence of interference, they will be over quickly. They are a disaster for retail investors on margin. I've never understood why the SEC doesn't gradually increase margin requirements across the board when the market starts to get overheated. (But not once it tops!!)
jewel 6y ago
Money isn't conserved in the same way that matter is. Right now the market cap of gamestop is $22B, which is calculated by multiplying the share price times the number of outstanding shares. If some news comes out over the weekend that causes people to value the stock lower, we could see the first trade at $33/share instead of $330/share. $20B of money just disappears. It never really existed in the first place.
- fractionalhare 6y ago
  Right. At the same time, there would be a net loss of value because any shorts who were margin called on GME's meteoric rise will have blown up. Their investors will have lost (possibly all their) money at the same time retail investors found their asks unfulfilled at $330 because the bids crash landed at $33. In this scenario both the short funds and the retail investors are fucked. A select few retail investors and some of the momentum-trading quants do well. But the majority of the money on either side just evaporates - rapidly. In a more distant but plausible scenario, this hits a bunch of funds across a bunch of tickers, and it goes systemic. They liquidate their longs trying to survive, and when it's not enough it rolls up into their brokers who are left holding the bag.

fractionalhare 6y ago

It depends. If a hedge fund went bankrupt, the cash will go to investors who may be risk averse. If the hedge fund survives it will have significant losses and probably be cagey about deploying a lot of capital again too quickly because it just stared into the face of death. In the case of individual investors selling off everything, they might be scared because everything is crashing. There's no rule that says the money will come back to the market quickly. It depends on investor sentiment. Often things have a V-shaped recovery and things are more or less "fine". We had a few of those over the past few years. But put it to you this way, if this statement of yours: It has to go somewhere, and so it will come back into securities in probably a few weeks or max, months. The value represented isn’t exactly disappearing it’s still in the ‘system’. ...was correct, then we wouldn't have crashes. But we do. When fear takes over the money doesn't just come back into the market quickly. And then even if it could, it doesn't because second order effects take over. Small businesses close en masse, etc, which magnifies the downturn until it snowballs into a legitimate recession. I'm not saying a crash will happen because of this. I'm saying it very realistically can happen.

smaddox 6y ago
There's also leverage/margin (i.e. borrowing to buy stocks). With higher volatility, investors might be less willing to use leverage, resulting in less total demand, which results in lower prices. When stocks drop, excess income and capitol drops, reducing demand in the wider market. Companies come under pressure to cut costs, and end up doing layoffs. This further lowers demand, resulting in a feedback loop. This is all described by Minsky's financial instability-hypothesis. And Steve Keen has built fully dynamic mathematical models that exhibit the process.
- codeisawesome 6y ago
  Okay - that begins to explain the problem a bit. So people being afraid and just holding on to their newfound gains in just cash or say, T-bills - can depress the entire economy by a lack of interest in stocks. Structurally it seems a little problematic though that companies would depend so much on issuing stock to fund their operations or even growth - ideally they should be able to do that with revenue (or even debt)...
adolph 6y ago
Alt hypothesis: Retail just learned a method of turning tables. Hedges will temper market moving short positions due to increased risk. Overall it’s a rebalance due to innovation.
- adolph 6y ago
  Alt alt hypothesis: smart hedges realized the overexposure while ago and wsb is schooling the dumb hedges who filled the vacuum. https://www.institutionalinvestor.com/article/b1q3cxqlbmltyl/The-World-s-Biggest-Short-Selling-Hedge-Fund-Is-Scaling-Back https://www.institutionalinvestor.com/article/b1q3cxqlbmltyl...

wrycoder 6y ago

It only becomes a big deal when the government steps in to "assist" in any way beyond providing copious liquidity. Downdrafts and even crashes are called corrections for a reason. They eliminate the weak holders and cause the remainder to carefully evaluate their positions. In the absence of interference, they will be over quickly. They are a disaster for retail investors on margin. I've never understood why the SEC doesn't gradually increase margin requirements across the board when the market starts to get overheated. (But not once it tops!!)

jewel 6y ago

Money isn't conserved in the same way that matter is. Right now the market cap of gamestop is $22B, which is calculated by multiplying the share price times the number of outstanding shares. If some news comes out over the weekend that causes people to value the stock lower, we could see the first trade at $33/share instead of $330/share. $20B of money just disappears. It never really existed in the first place.

fractionalhare 6y ago
Right. At the same time, there would be a net loss of value because any shorts who were margin called on GME's meteoric rise will have blown up. Their investors will have lost (possibly all their) money at the same time retail investors found their asks unfulfilled at $330 because the bids crash landed at $33. In this scenario both the short funds and the retail investors are fucked. A select few retail investors and some of the momentum-trading quants do well. But the majority of the money on either side just evaporates - rapidly. In a more distant but plausible scenario, this hits a bunch of funds across a bunch of tickers, and it goes systemic. They liquidate their longs trying to survive, and when it's not enough it rolls up into their brokers who are left holding the bag.