QuoteOriginally posted by: farmerAny time there are speculators - any time an asset's sale can be postponed - it creates problems for a price signal. Because you cannot separate the demand of end users, and the supply of producers, from the demand of speculators in the price. And obviously speculators can change their plans much more quickly than producers or users.A price may not be an "equilibrium" price, but simply a popular and temporary guess. It can help if you know that, for example, 50% of homes are owned by owners, and 50% of homes are owned or being built by speculators, whose intention is to sell them in the near future, rather than live in them. But this sort of information is impractical, and most economic activity evolves around the price ticker.There is a simple solution: price instability. In currencies, for example, trend traders push the prices as far as they dare one way and the other, so that immediate and long-term volatility generally match. So more specifically, the solution is immediate price instability that is indicative of long-term instability.The immediate price instability tends to regulate the balance of speculators. It is not random that housing, which is very illiquid and hard to change the location of, is where we have seen the most problems lately. Rather than in oil, or something, where people think of there being a lot of speculators. Because trend traders can run the price of oil up and down until they shake off speculators and run their stops, and at the same time find the bids and offers of end producers and consumers.So price instability in a liquid market tends to weaken the signal of speculators, which can lead to redundant inventories. And it reveals the signal of actual supply and demand levels of end users. The most useful piece of information would be like actual curves and elasticities for supply and demand. Running the price up and down the chart - such that speculators cannot hold prices at a single level long enough to completely hide actual demand levels - reveals such curves sort of like a sweeping radar image reveals 360 degrees of airspace.If you wanted to perform an economic experiment to determine actual demand for any good, what would you do? You would try offering it at different prices for periods of time, and see the quantities demanded at each price. Running it up and down extremely fast would allow you to detect a trend, like a really fast spinning radar gives you enough sample points to plot motion in a single craft.One implication of this, is that a "flash crash" is an extremely useful tool, like a fire drill. The more flash crashes there are, the healthier a market will be so far as planning patterns of production. We didn't have any flash crashes in housing for many years, and it certainly was no help to planning optimal leverage and patterns of production and speculation. A speculator must plan for a range of outcomes, and his plans are better informed by observing a range of outcomes while making his plans.Actually, price instability fails to reveal supply and demand because the tactic has two key assumptions. First, it assumes that the volume of purchasing of a product is equivalent to the volume of demand for the product. If a grocery store cuts the price of diapers in half, it will sell a ton of diapers in a short period of time but that's not because parents decided they can put their babies on high-fiber diets. Instead, the parents are speculating that the price of diapers will revert and they are increasing their household inventories of diapers in advance of the price increase when the grocer ends the sale. Second, the tactic assumes that genuine producers and users are risk-neutral. If a potential cookie factory owner sees volatile prices for flour, sugar, food oils, etc., then they might decide not to build a new cookie factory because the chance of the volatility accumulating to high ingredient prices (making cookies too expensive) would be too high.Small price excursions do strengthen those exposed to them but only if training matches reality and only if downstream players understand what's happening. If primary participants learn that someone is injecting 1% to 5% flashcrashes as artificial training, they will soon adapt their systems as if a 5.001% event cannot happen. And if secondary participants aren't aware that the primary participants are buffering the volatility (so that secondary players don't see any of the 1%-5% blips), then any shock bigger than 5% will wreck havoc on everyone.