True price discovery occurs at that point where you decide to sell an asset. Until that time you really don't know. And what its worth is a supply/demand function. The greater the supply the lower the price and of course the inverse is true - the lower the supply the higher the price.
At equilibrium there is a balance between buyers and sellers of an asset. If the asset is perceived as desirable the supply will contract and the price will climb. The inverse is true if an asset is deemed less desirable in that the supply for sale will increase and the price will decline. On occasion a very sudden and unforeseen event shifts the perception of desirability from very desirable to very undesirable.
Nassim Taleb describes such an event as a "Black Swan". The "Black Swan" causes an instant shift in sentiment that produces a very high supply of stocks for sale at that single point in time where the event becomes known. On occasion the "Black Swan" event is nothing more than the result of a high percentage of owners of an asset deciding to sell that asset at the same time.
The 1987 "flash crash" wasn't the result of anything more than that - simply an unpredictable and unforeseen decision to sell a large quantity of stock in a very condensed period of time. Any explanation for why that particular point in time is relevant, significant or any different than the days preceding or following the sell-off is nothing more than an attempt to make sense out of an event that didn't make sense. I remember that day as clearly as I remember the day President Kennedy was assassinated. Here's what the chart looks like.
The single most important consideration for investors today is the fact that the probability of a repeat of the 1987 crash is very, very high. This warning is relevant to small investors but probably not so much so to large investors. The truth is that large investors are stuck and there is little they can do to mitigate the damage at this point. Here's my point. A large investor who seeks to take profit will find that the price posted isn't really the price at all - at least the price he will get for a large block of stock. The reason - there isn't an equilibrium balance between those who want to buy and those who want to sell. You want proof of that point. Here's Google. The second chart is Symantec.
The Google "flash crash" produced a 3% drop in price based on the sale of 57,000 shares and Symantec fell 10% on 500,000 shares. Just to put the 500,000 share order in perspective the top 10 institutional investor's holdings of Symantec range between 58,417,616 on the high and 12,558,686 on the low. 500,000 shares is a big order but relative to the size of the large trader holdings it is not that significant.
In a liquid market where some degree of buyer/seller balance existed that trade would have moved the market a little but not 10%. If you think that stocks are clinging to all time highs because the economic outlook is so rosy you are wrong. They are clinging to all time highs because the so called "smart money" doesn't know what to do. They can't sell as there are no buyers - at least buyers that can absorb the "smart money" orders - that is to say large orders. By the way the idea that large traders are also "smart traders" is a bit of a misnomer.
I want to share this excerpt with you from an article on Zero Hedge the other day. The author's cynical style serves a purpose and also tends to inform us of what we really already know - stocks are simply not responding to the economic metrics that are signaling a rapid deterioration of the economy.
"Horrible" PMI, no problem; just add it to the list of macro data that has missed significantly in recent weeks. Bloomberg's US Macro index has utterly collapse (d) in recent weeks - now at its worst level in 7 months but apparently if good is good, bad is better, and totally shitty is absolutely awesome."
There is a reason that stocks are clinging to all time highs in the face of rapidly deteriorating fundamentals and it is no longer confidence in the Fed. We've seen a few attempts to exit the markets in recent days and the truth is there are no large scale buyers. Think gold - as I write this gold is once again accelerating to the downside. We are down $30 at the moment. Here's a look at the chart with my standard deviation grid overlay.
I've never seen a sell-off that pushed a market that far below mean. Gold was so oversold that the chart needed to catch up - therefore the spike higher. Today's price action suggests that we've finally corrected the severely oversold condition on gold and are prepared now for the next leg down.
Now think S&P 500. A move to 6 standard deviations below mean on the S&P 500 would push the price to 1233.00. Here is what the chart looks like current through today with the 6 standard deviation price added for effect.
That can't happen you say - well there is sure a lot of empirical support for the fact that it can happen. A little advice and I will close - the risk/reward at these levels is atrocious and the odds of a slow and orderly descent are not high. Don't expect a big warning this time as it would appear a "flash crash" is imminent.