Active traders and professional money managers already know how the U.S. stock market actually works, but Joe and Jane Citizen, whose pensions generally depend on the market in some way, typically do not. This entry is for them. Today's financial markets are endlessly complex, and this complexity implicitly serves to mask the true nature of market operations.

Most of this complexity can be boiled away with zero loss of understanding. Indeed, manipulating this complexity is what earns the big bucks on Wall Street, while boiling it away earns the big bucks for commentators and analysts. Thus complexity serves the financial industry extremely well.

The first and most important thing to understand about the U.S. stock market is how few humans are actually involved in the decision to buy or sell large blocks of shares. Machines do most of the trading. High-frequency trading (HFT) computers buy and sell millions of shares in milliseconds: Zero Hedge: From Chicago To New York And Back In 8.5 Milliseconds:

The reason why little if anything can and will be done to fix the persistent threat to capital markets that is HFT is two fold: i) none of the current regulators understand anything about modern market topology, and ii) HFT is so embedded in markets that unrooting it would result in a complete reboot of "fair" stock valuation.

That said it is always amusing to observe as more and more people get in on the scam that is the "equity market", now completely dominated by robots which do nothing but accelerate and perpetuate momentum moves - after all it is all they can do in lieu of being able to read financials, or anticipate events. Remember: it is always the market that makes the news, never the other way around.

In essence, HFT is a gigantic skimming operation that exploits tiny differences in the bid/ask prices of stocks to buy and sell millions of shares for slivers of profit that are multiplied by millions of shares traded in seconds. Raging Bulls: How Wall Street Got Addicted to Light-Speed Trading (Wired Magazine, via Zero Hedge).

Other computers are programmed by math-wizard "quants" to trade momentum and technical signals. Since everyone in today's markets has access to the same technical triggers and data, computers are programmed to respond to these signals.

For example, days with large pre-market buying of S&P 500 (SPX) futures contracts tend to open up, so trading robots will buy at the open and ride the momentum up. If the market rallies by 3 p.m., the odds of it closing higher are very high. This is how keying on momentum yields low-risk profits if the trading involves millions of shares that are held for microseconds, seconds, or minutes.

Here's another example: if technical analysis (TA) has identified SPX 1,366 as a key level, then once the market surges above 1,366, the trading robots will buy into the move.

The second important thing to know about the stock market is that central banks and governments intervene as buyers to trigger rallies and put floors under declines. As noted above, huge buying of futures triggers opening rallies. It is a poorly kept secret that central banks or officially sanctioned but cloaked "plunge protection teams" are doing the buying.

Once again it is relatively easy to steer the market because humans and computers alike are keyed on certain well-known technical signals. For example, if the 200-day moving average of the SPX is 1,300, and the index dips down to that level, computers are programmed to sell if it breaks below that support level or buy if it spikes above it.

Authorities need only issue massive buy orders at these critical levels to "stick-save" markets from declines.

As regular folks continue to pull their money out of the market, either tiring of losses and volatility or recognizing it is rigged to their disadvantage, trading volumes have declined, making official but "secret" intervention both cheaper and easier.

Just as the U.S. stock market now depends on high-frequency trading, it also depends on official intervention to stop any decline.

How is it legal for HFT computers to skim profits that are unavailable to human traders? Clearly, this is legalized fraud, or if you prefer, embezzlement.

The third thing to know about U.S. stock market is that their operations are opaque, invisible, and hidden from the citizenry and non-Elite human traders. How much of the market volume is computers skimming via HFT can only be estimated. Official buying to spark rallies or stop declines dead in their tracks is also hidden from the citizenry.

Huge volumes of shares are traded off the public exchanges in so-called "dark pools" that are also hidden from the citizenry and non-Elite human traders.

How "fair and open" can an exchange be when its critical operations are hidden from public view? Answer: it cannot be fair and open. It is rigged to favor Elite players, who are allowed to legally skim billions of dollars in profits by means which are unavailable to non-Elites investors.

This vast skimming operation is enabled, enforced and supported by the Central State and the (privately owned and operated) Central Bank of the U.S., the Federal Reserve.

The Pareto distribution can help us understand how the market really works. Though it may well be that a mere 10% of stock market volume is human-traded shares, let's assume the 80/20 rule applies and 80% of the shares are being traded by 20% of the traders, most of whom are machines.

Taking the distribution one step further, we can estimate that 64% of the volume is executed by a mere 4% of the players.

The fourth and last thing to know about U.S. stock markets is that this skimming and intervention have left the markets extremely vulnerable to collapse. Official but secret intervention is called the "Bernanke put," meaning that the Fed will intervene to keep the market aloft, regardless of what is happening in the real world of the global economy.

This faith in central-planning manipulation of the market has encouraged an extremely high level of complacency in traders; they confidently trade the market higher, knowing that the Fed will never let it fall.

But this leaves the market exquisitely vulnerable to high-volume selloffs that roll right over the Fed's rather modest buying power.

Since HFT and quant trading robots are programmed to buy and sell at commonly-known technical signals, if certain levels are broken to the downside, the selling will quickly avalanche as trading machines issue sells.

Leaving 80% of the volume to programmed computers leaves the markets extremely vulnerable to cascading momentum selling. If you live by momentum trading, you also die by momentum trading.

If you wanted to design a system that was eventually guaranteed to crash, then you'd design a system that is dependent on opaque official intervention and HFT/quant computer trading for 80% of its volume. That's the system the Central State, the Fed and the financial Elites are supporting and enforcing because it's an enormously profitable skimming operation that is also a supremely useful tool for managing perceptions: if the market trend is always rising, then the economy must be improving.

This is of course a false correlation: the market is hitting highs while the global economy is unraveling.

Beneath the surface stability, the Fed, the State and the financial Elites have constructed a terribly unstable system for skimming unearned wealth and propping up a propaganda facade of economic "improvement."

If watching a tiny Elite skim billions of dollars from the real economy with the aid of the Fed is your idea of "improvement," then by all means, buy the rally. Just be ready to sell in 10 milliseconds.

Entries and email may be sporadic this week due to other commitments.

Read the Introduction (2,600 words) and Chapter One (7,600 words) for free.

We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.

We cannot know when the Central State and financial system will destabilize, we only know they will destabilize. We cannot know which of the State’s fast-rising debts and obligations will be renounced; we only know they will be renounced in one fashion or another.

The process of the unsustainable collapsing and a new, more sustainable model emerging is called revolution.

Rather than being powerless, we hold the fundamental building blocks of power. We need neither permission nor political change to liberate ourselves. A powerless individual becomes powerful when he renounces the lies and complicity that enable the doomed Status Quo’s dominance.

If this recession strikes you as different from previous downturns, you might be interested in my book An Unconventional Guide to Investing in Troubled Times (print edition) or Kindle ebook format. You can read the ebook on any computer, smart phone, iPad, etc. Click here for links to Kindle apps and Chapter One. The solution in one word: Localism.


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