Why is there so much trading? – A new addition to my Blogroll

I happened upon The Market Completionist today; Evan Jenkins, the author, writes very well on a range of more or less theoretical market concepts (e.g. efficient markets hypothesis/CAPM).  I only wish he’d write more often.

Anyway, reading his older posts, I happened upon this one addressing market information efficiency.  Among the ideas, the post asks why there is so much trading, when very little is required to achieve information efficiency.  In sum, informed traders will look to ‘pick off’ uninformed (noise) traders, such that the latter should run away/not take the other side of the trade unless duly compensated.  I imagine the end result of this is (similar to the study cited in the post) a market with very infrequent exchange, and discontinuous prices.

As an aside, this sounds a bit like the residential real estate market.  When you’re looking to sell your house, you’re looking for a buyer that hopefully gets an emotional attachment to the property; that allows you to extract a surplus from the buyer based on his/her irrationality (or maybe a rational ’emotion’ premium?).  Same when you’re buying a house: you want the seller to think you’re an emotionless market-maker, who demands a large discount to take the other side of the trade.  Where shall the two meet??

Anyway, I’m very happy that most financial markets these days have a great deal of (over?) trading.  The reason is simply price continuity.  Not only do I feel very confident that my shares in AAPL are worth the latest closing price (i.e. I know the value of what I own); but I’m reasonably confident that, should the need arise for me to sell my shares, I can achieve a price very near what I’ve seen posted on Google Finance.  As a house-seller in 2010, I can very much appreciate the latter point.

I guess we’re back to that old ‘market-makers/HFT as a service provider’ topic.  Does there need to be so much trading to ensure information efficiency in markets?  Probably not.  Am I still sanguine with the idea that so much trading takes place?  Sure.

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