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> And the bigger indices grow, the larger the opportunities for active traders to profit. I'm having trouble understanding why this is the case. Care to clarif
by ipsum2 10y ago
> And the bigger indices grow, the larger the opportunities for active traders to profit.
I'm having trouble understanding why this is the case. Care to clarify?
- adrianN 10y agoIndex funds are buyers that don't think. If you have information that a stock has the wrong valuation you can sell to an index fund.
- alphadevx 10y agoIndex investments are still investments, they help push up the prices of the stocks they buy too. That creates opportunities.
- awjr 10y agoYou also have the situation that index funds must buy or must sell a stock if it enters or leaves an index. This creates an opportunity for active traders.
- kennethh 10y agoMost indexes are fairly predictable, so the changes are usually frontrunnered by index funds and traders.
- bdonlan 10y agoIndex funds buy or sell blindly, at whatever the prevailing best price is. Naturally, if there were only index funds in the market, the price would vary randomly. That being said, consider what would happen if stock prices did start to vary randomly - if you had actual research suggesting the price was too high or too low, you could trade accordingly. This would net you a profit, and also help push the price in the opposite direction, towards whatever a reasonable price is. The larger the deviation from the "correct" price, the larger the potential profits are to be had. So if the problem ever starts to be significant (i.e. a few cents of deviation caused by index funds), this means a very large potential profit for any active funds or traders out there. And so we would expect the system to reach an equilibrium - where there are just enough active funds and traders to snatch up the profits that arise from tiny price errors and distortions caused by index funds. In effect, the index funds are paying those remaining active funds and traders a tiny "management fee" (in the form of exploitable trading behavior) to figure out the appropriate price of stocks for them!
- gcb0 10y agostock prices Do vary randomly.
- rjtavares 10y agoI'm assuming that is a reference to the random walk theory. That theory suggests that "the past movement or trend of a stock price or market cannot be used to predict its future movement". It's random in the sense of unpredictable, not in the sense of actauly being determined by chance. The implication of the random walk theory is that current information is already uilt into the price of the stock. That is only true insofar as there are active traders acting on that information. The parent is merely explaining why those traders will exist, and why you only need a small part of the market to actively trade.
- hueving 10y agoRandom walk depends on all participants acting rationally based on the same information released at the same time. However, index funds are not rational, they always buy in the same ratios regardless of news.
- aangjie 10y agoI'd suspect all those HFT firms will have robot agents (trading based on some ratios/logic) as simulations for their testing environment.
- deleted 10y ago[deleted]
- galfarragem 10y agoResuming, as I understand it: Good stock pickers > Index Funds (blind money) > Bad stock pickers By investing on index funds you are betting in the average of the average (a fund is already an average of undervaluated and overvaluated stocks). However, by investing on managed funds your probability of having profits over index funds is low: even if stock pickers that beat the market (by definition) amount to 50%, extra fees make most of them still less profitable to investors than passive funds. [edited]