Mandelbrot trading: the fractal looting of retail investors

Benoit Mandelbrot is probably best known for fractals, self-similar structures. Here are charts of the S&P 500 over the last three months and over the last 13 years.

They both represent range-bound trading, in which the index goes up and down, but never establishes a trend. But the scale they occur on is vastly different. Interestingly, the ups and downs of the range within which the three-month chart is trading represent slightly more than the long-term annual average rise/fall of the market.

A trader, as opposed to a long-term investor, can make money in such range bound markets by buying low, selling high, and going short at the peak. Just taking the peaks and troughs between 112 and 120, a trader could makes something like 50% profit (exclusive of taxes) in three months. It’s like making seven years of normal profits in three months.

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I suspect that that’s just fine with the Goldmans of the world.

The problem is that extended periods of range-bound trading provide no incentive for investors who can’t take advantage of these short-term strategies. Retail investors and institutional investors (like pensions) accurately understand that this is gambling and, further, that they are not the house. If you had your money in the stock market for the last 10 years, counting dividends, brokerage fees, and taxes, you have no more money, and what you have buys a lot less.

The point of investing long-term is to take advantage of the natural growth of healthy companies. You only get burned if a company pulls a Carly Fiorina or if the nation elects a George W. Hoover, and even so, if you don’t need the principal right away, you at least have the dividends. But wen traders and speculators dominate, markets are ripe for collapse.

Barry Ritholtz has an article in which Felix Zulauf is predicting a rotten economy (and a bear market) until 2017. I don’t think he’s right, because I think that the economic conditions will provoke an upheaval that will bring an end to high-churn activities. That can be accomplished by raising the short-term capital gains tax and additionally taxing high-frequency trading. My date for the end of the bear is 2014. But then, I’m always optimistic and, besides, it may take some time for ordinary investors to start risking capital again. The one thing that could really advance that cause is raising wages. Once people have savings to invest, the markets will recover, assuming that people don’t in the meantime decide that capitalism is just too toxic.

The solutions are not complicated. They would benefit everyone except the Goldmans.

Which means, I suppose, that they’ll never happen.