The trading floor of the Chicago Board of Trade during business hours on a normal day would fit anybody's definition of chaos. Each trading pit is filled with screaming, arm-waving, gesticulating traders jumping up and down, scribbling on little pieces of paper, and handing notes back and forth to ``runners'' shuttling to and from the wire terminals where orders are received. This is an efficient market at work on a normal day. Since there are a large number of orders to buy and sell at many points around the current price (hence the many pieces of paper in the traders' order books), movements in price will be close to continuous. Since there are a large number of buyers and sellers, including floor-based ``scalpers'' or ``locals'' willing to make trades of less than a minute's duration to turn a profit of one tick in price, the market can accept large buy or sell orders without discontinuous price changes (it is unusual in a market this liquid for consecutive transactions to differ in price by more than the minimum increment of quotation, even if the overall price swings in a day are large). That a well-balanced, highly-liquid, efficient market near equilibrium looks like a cockfight where somebody forgot the chickens is evocative of the intellectual tension between the apparent messiness and anarchy of markets and their usually smooth functioning in practice.
What happens when the market diverges from equilibrium? Two days before I wrote these words Ford Motor Company issued a press release to the effect that their researchers had made major progress in developing a catalytic converter for automobiles that required no platinum. This news hit the platinum market, which had been rising strongly for much of the last year, like a sledgehammer. Now the Ford announcement, which simply reported that patents had been granted on a device which would undergo initial tests in 1989, had absolutely no impact on the near-term supply and demand for platinum, for which automotive catalytic converters represent 30% of the world demand and 60% of the U.S. demand. Nonetheless, the announcement caused a huge number of sell orders to hit the platinum market while most participants scrambled to figure out the actual significance of the development.
What did the platinum pit look like after the news arrived? Chaos squared? No, it was dead. Futures markets have daily trading limits, so when all the sell orders hit the market it simply went down the limit and business ceased because there were no buyers at the limit-down price. This was a market out of equilibrium, a market where the disequilibrium caused volume to dry up, and thus the price-setting function of the market temporarily ceased to function. (Although daily trading range limits are unique to U.S. futures markets, the same effect would have obtained in any other market through different means. On the New York Stock Exchange they call it ``stock closed by the specialist due to order imbalance''. On NASDAQ the broker-dealers simply remove their bids from the system or stop answering their phones.)
The only thing one can predict with certainty in a market is that equilibrium will be re-established at a new price, and trading will resume its chaotic course from that point.
Editor: John Walker