what moves stock marketsRecently, global stock markets have been rising and falling (mostly falling) in sharp, jerky motions. But the explanations investors get about why the markets move the way they do aren't worth the paper on which they're printed. It's an issue I've written about many times before, such as back in September 2008, on a day when the Dow fell 345 points. And this failure goes to the heart of whether investors should trust their retirement to stocks.

The basic problem is that what business journalists write about stocks doesn't explain what makes markets move. This failure reveals three dysfunctions of financial journalism:

  1. Repeating analyst quotes as if they were explanations;
  2. Confusing coincidence with causality;
  3. Using the stock market as a forum to spout political opinions.
Let's examine the first dysfunction: Journalists need to write about the market's movements because their editors ask them to. So journalists ask so-called market experts, who, in order to keep appearing to be experts, must say something other than "I have no idea." So they make up answers, which the journalists write in their articles -- and that makes their editors happy.

Stocks and Superstition

As mentioned, the second dysfunction is that journalists confuse coincidence with causality: They create the impression that because an event occurred on the same day as a market movement, it must be the cause of that movement.

An recent example of this occurred around the recent sharp stock market declines that were blamed on concerns about eurozone debt. But the facts don't bear that out.

The problems with eurozone debt were well known to investors at least a month before the March 26 announcement of a Greek bailout plan. And from that day until April 23, the market kept going up. Naturally, business journalists didn't haul out European debt problems to explain market movements during that month -- after all, bad news would be a poor excuse for markets rising. It was only when the markets started to fall in late April that journalists decided that eurozone debt was the most likely explanation -- when in fact it was just a coincidence.

A final dysfunction of financial journalism as it's practiced on some media channels is to confuse political propaganda with market analysis. I was interviewed on such a channel earlier this year by a host who predicted that the market would rally when Massachusetts state Sen. Scott Brown won the late Ted Kennedy's U.S. Senate seat. When the market failed to rally after Brown's victory, the host asked me to explain why his prediction had been wrong.

A "Simple" Way to Discover What Moves Markets


So what does make markets move up or down? As I wrote in an article on DailyFinance last month, those seeking an explanation should look no further than the reasons why the biggest volume traders buy and sell. To that end, a simple three-step process is required:

  1. Identify the traders who account for most of the trading volume in stocks on a given day;
  2. Ask these market moving traders to explain why they bought and/or sold the specific securities they traded that day;
  3. Verify the explanations through independent sources.

Of course, this will never happen unless the government requires it, and there doesn't seem to be a political push for such disclosure. One reason for that could be that traders profit from the lack of such disclosure requirements, and that a portion of those profits find their way to Washington in the form of donations to political campaigns. Unfortunately, there is no hard evidence of this connection, so it's just a hypothesis that resists being tested.

But consider this: I've seen many reports claiming that "flash trading" accounts for 70% of daily market volume. Flash traders hold securities for an average of 11 seconds. That doesn't leave much time for an analysis of the probabilities that the eurozone will default on its debts.

For Many, Money Market Funds Are a Better Bet


Meanwhile, investors still seek 8% annual returns to prepare their retirement nest eggs. But how can they trust their savings to a market of securities in which the most basic information -- why prices move up or down every day -- is not available?

The answer is that many are keeping their funds in money markets that, at the moment, are earning nearly zero percent interest rates. At least the nearly $3 trillion in money market funds has been able to hold its value better than other alternatives. (Yet compared to the most recent 44-year-low inflation level of 0.9%, at 0.03%, those money market funds yield less than the general rise in prices. The "good news" is that money market rates of return will go up if the Fed raises rates to fight inflationary expectations.)

But for those who need actual investment appreciation, the risk of going into stocks seems way greater than the potential returns. If we knew what actually made stocks move, it might be easier for investors to weigh those factors and make informed decisions.

Increase your money and finance knowledge from home

Forex for Beginners

Learn about trading currencies and foreign exchange transactions

View Course »

Investment Strategies

What's your investing game plan?

View Course »

Add a Comment

*0 / 3000 Character Maximum