Buyer See Buyer Do

Vol #55 - October 8th, 2021

“This is the new normal”. 

I heard that quote from a former colleague regarding the paradigm shift that equity and options markets have undergone over the last two years. Meme stonks aren’t a passing fad, but how investors new and old approach the market has changed. 

The level of participation from retail traders has exploded in equity options. Much of this credit goes to discount brokers providing cheap and easy access to the markets. Combine this latent technology with the timing of the pandemic and an explosion of accessible information and you have rocket fuel for markets.

When I first started in the options business, our training class was given a copy of Sheldon Natenberg’s “Option Volatility and Pricing”. This was considered the academic bible of how to think about options.  Read the book, then quietly sit next to a trader and watch them practice their craft. With enough repetitions, one day you’ll know what is true jade. 

You don’t see much citing of Natenberg today, because there are Twitter threads that are teaching graduate level concepts in volatility modeling or flow trading. Message boards are riddled with new traders asking complex modeling questions that yesterday’s veterans never had to consider. The quantity and quality of information available today is astounding. 

One of the rules that I always found ironic for exchange floors, was that when orders were announced in a crowd, that was considered “public” information. Typically before an order ever made it to the floor to be traded, it was socialized amongst dealers over the phone or instant message to find counterparties and arrive at pricing. Those dealers, however, could not make trading decisions based on that order until it was announced on the floor or they would risk being censured for acting on non public information. 

Trading floors never felt like a “public” place, so that rule always seemed weird to me. But now thanks to social media the tips, tricks and techniques of those traders are now widely shared with the public. It is good news for markets when discussions about how they actually work move out of the back rooms and into the public discourse. 

We credit social media for also giving rise to meme stonks like AMC or GME, but the truth is that investing has been mimetic for as long as there have been investors. 

Mimetic desire is a framework for understanding human behavior through the source of our desires. French philosopher and historian Rene Girard is the originator of this idea, and describes the root of man’s behavior as such: 

“Man is the creature who does not know what to desire, and he turns to others in order to make up his mind. We desire what others desire because we imitate their desires.”

Even if we are crass enough to admit that we crave wealth and status, our means of demonstrating that is highly unoriginal, and only comes from imitating what other people desire. Alongside man’s inherent competitiveness, this imitation of desires creates a strong positive feedback loop. 

George Soros identified this in the markets early on in his investing career. He describes markets as exhibiting reflexivity and feeding on their own momentum rather than some independent truth.  His book “The Alchemy of Finance” lays the foundation for this positive feedback loop, and identifies numerous markets and cycles where this has happened.  

Markets are born to solve the difficult problem of valuation. There is no correct answer for what a share of Apple Inc is with today, there’s only a market price. Whether you use discounted cash flow, technical analysis, or a top down comparables approach, it’s simply an educated guess. 

Buyers meet sellers to arrive at a tradeable value. Commodities traders will tell you that the cure for high prices is high prices. In other markets like Bitcoin, high prices can beget even higher prices, sparking enthusiasm and FOMO as headlines tease all time highs. 

When you peel back the technology, the new normal looks a lot like the old normal. Markets are fundamentally about animal spirits, and the competitive human desire to find an edge. Whether it comes from a message board or an old fashioned newsletter, when prices tick green, buyers want what earlier buyers have.