I can live with risk as measured by the volatility of markets. What is harder to live with is the risk or uncertainty on the rules of the game or the structure of markets. While there has a focus on the wild moves in some equities attributed to retail herds, crowds, or swarms, there has been less attention to what is happening with the rules of the game.
Investor should expect increases in margin for volatile stocks, futures and options. This is a rule of the game. You may not like it, it may come at the wrong time, and it may actually further increase market volatility, but it is part of the game. Cash has to be reserved for this contingency. However, what happens if some brokers restrict trading in specific names given their capital requirements. It is within their rights and it may be a prudent call to protect the business, yet if an investor does not have a contingency for this change, there will be a whole new level of business risk.
The rules of the game also mean there can be short squeezes. If short interest gets so large, normal dynamics will be adjusted to account one-sided behavior. Borrowing costs will increase. Long will account for their advantage by just not selling.
Extreme behavior leads to extreme responses and like a car that begins to skid a quick response may be the real problem and feedback gets reinforced and accentuated. And, we have not even begun to see the response by regulators.
Is a structural response necessary to these market moves? An immediate answer is yes. Markets cannot be driven to either meltdowns or melt-ups by a feedback loop of trading driven by non-fundamental excess whether it be from the long or short side. Uncertainty can be minimized by reducing ignorance and know how the market structure works and what rules may change.
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