Chasing the Same Signals: How Black-Box Trading Influences Stock Markets from Wall Street to Shanghai

Chapter 9. The Ecology of the Marketplace

Whatever Happened to the Buy-and-Hold Investor?

The "ecology" of the financial markets is a term borrowed from biology to describe the relationships between investors and their environment. It is an appropriate analogy because just as ecologists study the impact of various species on their ecosystem, economists study the impact of investment strategies on the marketplace. There are many parallels between biological systems and the financial markets.

When Europeans brought rabbits to Australia in the 18th century, there were devastating effects on the ecosystem, leading to the extinction of many orchards and plant species. In a similar light, when the Australian Stock Exchange eliminated the dissemination of real-time market share information to its member firms in 2005, there were significant declines in market share for the local brokers, such as Macquarie Bank, because of the elimination of their information advantage on the foreign investors. Any subtle change in the market structure can have a profound impact on the population of the market participants.

Economists believe that the financial markets will remain in a prolonged period of instability if there is not equilibrium by the participants. In an ecosystem, if one species of the population is too abundant, than the food supply will be scarce. Similarly, in finance, if there are too many investors employing the same strategy, then the profit margins will be thin. Instability is the ...