Nov

24

Tasmania’s land bridge to the Australian sub continent was flooded about 14 thousand years ago, which cut off the isolated island from all outside influence. The land enjoyed a cool but stable climate untouched by ice ages. The relative isolation, the lack of predators and the stable climate and geological environment led to the evolution of relatively docile, primitive and slow moving marsupials which survive today in abundance. The aboriginals were exterminated completely by the Anglo-Saxons. There are now few humans, making Tasmania the least crowded, cleanest first world developed place that I have ever visited. The half a million very friendly, talkative and hospitable people are 99.999% of European descent. They and their children appear to have much less anxiety and stress than Europeans, Americans and Asians from more crowded areas. The cities reminded me of Portland Oregon 40 years ago and San Francisco 100 years ago.

The primitive marsupials tended to be gentle, docile and slow moving due to the low environmental stresses. This is compared to aggressive placentals such as the fox which was a recently introduced problem in Tasmania. Though there were only a few cars per hour on the roads, road kill was abundant. The hypothesis is that the low environmental stress leads to less aggression and slower moving adaptations. There were impressive predator birds such as Harrier hawks swirling close with sharp eyes for unwary prey hovering close to the road sides. The image of the speculator as the predator hawk and the docile foragers as the prey is apt. The marsupials have interesting adaptations to stresses (such as drought). They can have three embryos, each on a different feed teat, and can retard development of the embryo when conditions are harsh, or speed it up when feed is abundant. Unfortunately the last Tasmanian tiger, a marsupial carnivore, was killed in 1936 and is now extinct. Even high level predators suffer extermination at the hands of even higher level killers, in this case the humans. When a storm blows the rain, all the sheep face in the same direction.

How can the lessons from Tasmanian ecology help with an understanding of the market ecology? The current remarkable low volatility market reminiscent of the Tasmanian experience leads to the hypothesis that the long periods of low stress and low volatility promotes docile and slower moving participants and slower evolution. Applying this to the current market we observe that there has not been any new 20 day lows for 90 days now, and there has been a steady march upwards with low volatility. There has not been a 20 point open to close drop for almost a year since 2006-01-20.

As with physics and geology, the study of micro structure allows insights into macro and cosmic structures and function. The same holds true in finance where micro structural elements can explain markets. A descriptive theory for the reason for the low volatility is that the CME futures are causing or contributing to the broader markets low volatility. CME equity index futures hit record high volumes CME E-mini equity index volume set a monthly record of 2.1 million contracts per day, up 70 percent, and a quarterly record of 1.7 million contracts per day. Globex does not have true market orders but limit and modified limit orders only.

As explained by O’Hara in Market Microstructure Theory and by Osborne in The Stock Market and Finance, it is the interest of the market maker to have only limit orders to avoid the uncontrolled gaps that pure market orders cause in panics, without specialists where the market makers get caught with an inventory imbalance. With only limit orders micro-structural theory predicts the benefits to the exchange and the market makers resulting in the steady clicking up and down in orderly increments of limited price change, allowing maximum profit to the exchanges with maximum volume and steady but small price changes to benefit the market makers. In fact we see the increase of market making type behavior in the predicted market motion of a steady clicking up and down and very structured waves in the market with relatively low volatility and limited ranges. The behavior is characterized by a buy at or near bid and a sell at or just above ask. A steady click up and down in limited ranges allows a steady foraging income to the participants. This explains in part the current low volatility index future type action. As more participants are attracted to this cycle by necessity, the volatility goes down and size and leverage goes up. The tail wags the kangaroo as arbitrage causes the rest of the market to start following the future and further decreasing volatility. If this hypothesis is true, it is not likely for volatility to increase cyclically which is what Professor Ross has been telling us as well. There are periods when the density thins, such as right before an announcement, and the resultant opening up of volatility, but it shuts down right away. When a storm blows the sheep face in the same direction. This type of low volatility foraging allows growth of the population as there is steady and adequate food for these participants, but complacency is dangerous as population grows and the demands on the food stock and competition for resources increases. This is why the fox is so dangerous.

Evolutionary cycles and the market ecology require adaptation to survive and prosper. This might mean avoiding overcrowding over grazed foraging areas. It means developing better predatory tactics or low effort foraging. Mid level predators such as foxes and harrier hawks need to avoid extinction by higher level market participants even in low volatility environments. The smaller operations are at risk from large farming/hedge fund operations and their need for bigger trend moves or perhaps vice verse. As in nature, in the markets, understanding the cycles and their causes enables survival and prosperity.


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