The logical answer is “stocks go up and down.” Let’s get more specific. Among the 20 largest asset managers at the end of 2009, ten were bank-owned, says consulting firm Towers Watson. The five largest – Blackrock, State Street, Allianz, Fidelity and Vanguard – are independents that pass the preponderance of their buying and selling through the biggest sellside firms on passive equity and ETF trading programs.

The banks behind ten of the twenty largest asset managers include BNP Paribas, Deutsche Bank, JP Morgan, BNY Mellon, Credit Agricole, UBS, Goldman Sachs, HSBC and Bank of America.

The top ten futures brokers for 2009 were Newedge (Societe General/Credit Agricole joint venture), Goldman Sachs, JP Morgan, Deutsche Bank, Citigroup, UBS, BofA, MF Global, Morgan Stanley and Barclays.

The five largest banks behind derivatives contracts, according to the US Treasury are JP Morgan, BofA, Citigroup, Goldman Sachs and HSBC and the top 30 banks control nearly 100% of this business.

The top prime brokers offering value-added trade-execution services to investment managers in 2010, according to Global Custodian, were Credit Suisse, Deutsche Bank, Morgan Stanley, Goldman Sachs, JP Morgan, BofA Merrill, Newedge, UBS, Citi and Barclays.

The twenty-odd primary dealers for the Federal Reserve’s security auctions include most of the banks mentioned here, from BNP Paribas, to MF Global (formerly hedge fund giant Man Financial), to UBS.

Tracking trading, we have observed big gains in equity program volumes for BNP Paribas, Newedge and Credit Agricole. Barclays, Goldman Sachs, Morgan Stanley and Credit Suisse dominate still.

Do you see the pattern? The same banks that manage risk also drive trade executions. The ones that underwrite futures and options also help money shift from equities to futures and options. The ones managing the movement of government money are behind program trading in equities.

And the rules, from how trades match, to order-types, to best execution, to order-routing practices, are uniformly decreed by the SEC. Risk-management requirements are so steep that just big banks qualify to handle massive globally sloshing cash.

Thus, the answer to our opening question is this: When investors buy and sell, their liquidity becomes a tool for trading tactics that may be the exact opposite of what the investors actually think about your shares. Liquidity flows to prime brokers in fragments that congregate into tributaries forming a mighty stream that meets execution requirements and fuels index arbitrage or relieves counterparty risk.

But it’s not fundamental. It’s a device controlled by the few who transfer risk from asset class to asset class.

As you head out this autumn fulfilling the IR tradition of traipsing to sellside conferences, don’t forget the small brokers, the boutiques. Maybe they will buck this monochromatic crowd.

Yet often, boutiques can’t execute trades for investors who buy and sell stock on merits. They may be unable to meet SEC best-execution requirements. So they route to Morgan Stanley, which rolls orders into programs to earn rebates from exchanges, while simultaneously fostering index-arbitrage schemes with algorithms for top clients.

If this bugs you, IR pros, read everything you can about how trading works now. Then tell your management. It’s a place where IR can shine. The rub inescapably rests with the well-intentioned but unfortunate rules that cause all the money to work the same and look the same and flow to the gigantic few.

To borrow the title of a Bob Saget HBO comedy special, “That ain’t right.” And it can change.

We were there, clanging bells and hooting our hearts out. Here is winner Levi Leipheimer readying for the time trial that put him in yellow. The peloton left Avon here for Steamboat, and Levi is visible midway in yellow. At the finish, some 250,000 jammed downtown Denver for the epic, lapping conclusion. We are proud of American cycling and our state’s awesome organizational effort.

Speaking of peloton, Wall Street Journal reporter John Jannarone wrote Monday in the Heard column called “Traders Seek Salvation from Correlation” about how stocks race in formation. It’s among the best pieces we’ve seen on modern trading. Jannarone says that S&P 500 stocks show 80% correlation in the past month, meaning eight in ten move synchronously.

This is a source of distress for IR folks trying to distinguish a strong company story from the herd. We’d argue that rather than slamming the collective IR noggin into the burgeoning brick wall of macro-focus investing that you instead track program trading and establish what level is acceptable – and use it as an IR success measure. We wrote about this last week, so we won’t retrace the trodden path.

Why a mirror image across so much of the market? One driver Jannarone posits is Exchange-Traded Fund investing. According to Credit Suisse, these drive some 30% of daily stock volume. Jannarone also notes that trading in S&P 500 E-mini futures contracts is more than four times the combined daily volume of the two biggest S&P 500 ETFs, the SPDR, and iShares S&P 500 Index ETF.

It’s a reasonable hypothesis. If institutions trade ETFs and indexes, and hedge them with futures and options, and try to increase yield by leveraging assets with yet more futures or options in, say, currencies and Treasuries, stocks will correlate in models, and markets will reflect high volatility due to continual adjustments to these layers of equities and derivatives.

We see it, measuring speculative and program-driven trading for clients. These two dominating behaviors are also increasingly correlated. More money is pursing short-term “investment” horizons designed to produce returns in days.

Jannarone worries as do many investors that correlation is likely to last because of currency concerns. We agree. So IR should quantify market activity and report on it regularly to management. Otherwise, we’re bystanders. It’s better turning lemons to lemonade than sourly wondering when rational investment will return.

We suggest you hop on that bike and ride it.

That seems the attitude about market gyrations in August. Prices recovered. Heck, we should’ve skipped the mess and stayed on the Cape.

Across our client base, we saw few rational-price changes between Aug 1 and Aug 12. Rational investors were not responsible aside from stop losses triggering reactions. Trading data do indicate sizeable shifts in assets by global risk managers.

We talked about that last week. Responses to currency fluctuations. Institutions transferring risk by moving money continuously via electronic markets from bonds, to equities, to derivatives, to currencies. With fear of a currency meltdown rising, risk managers engaged in random, computerized, global buying and selling to discourage everyone from running to the same side of the boat and capsizing it.

We’re convinced that techniques developed after 2008 were employed to blunt this “tail risk” crowd behavior. That’s the chance that everybody does the same thing at the same time, destroying global portfolios in a mad rush. Computers randomly bought and sold. The lack of a trend reduced the risk of a rout.

By the way, we’re sponsoring IR Magazine’s November Think Tank in New York. Our segment is on Tracking Trading: Separating the Signal from the Noise. Joining me on the panel is Joe Saluzzi of 60 Minutes “High Frequency Trading” fame. Don’t miss it.

Here’s what I want you to ponder, IR folks. One major client averaged 377,000 trades daily and nearly $2.4 billion in dollar-volume each day, more than double norms. Who made that extra $1 billion daily? Where did it come from?

That’s  one example. We saw high-frequency percentages over 71% (and as low as 56%) in our mega-cap clients last week, but HFT percentages were high everywhere, even for the smallest clients.

As we’re fond of saying, markets tromp about today in two shoes. One, the asset; the other, the hedge. So if currency fluctuations prompted the move, and HFT soared, is the second shoe effectively a way for central banks to bleed excess cash off the stagnant global table via high-frequency trading?

The biggest HFT firms were active, to be sure. Hudson River, Sun Trading, Two Sigma, Quantlabs, Getco, RGM, Tradebot. But so were the biggest global broker-dealers and program traders including Barclays, Deutsche Bank, Goldman Sachs, Morgan Stanley, BofA Merrill Lynch, Citi, Credit Suisse, Latour Trading.

The two groups were virtually indistinguishable in their behaviors. They were both engaged in HFT. Did central banks transfer billions of dollars out of circulation through broker-dealers and HFT?

We track data and correlate our conclusions to known, identifiable metrics. And we’re just sayin’.

Speaking of needing things, there’s a flaw in consensus estimates. Consensus by definition means it’s the general view. But the general view reflected by estimates of earnings, revenues or cash flows comprises less than 15% of total market volume.

Across the market, we find that about 12.5% of substantive volume is what we’d call rational – driven by thoughtful investment derived from fundamentals. How can this be? Great swaths of trading today are driven by relative value – the current value of this basket of things versus that basket of things.

Somewhere around 30% of volume is this kind of trading that we consider program trading. It’s driven by market factors and relative value. After all, currencies that denominate securities have only relative and not intrinsic value. Should we not expect trading instruments to behave the same?

What’s more, some 65% of total market volume on average is just air created by the maker/taker model prevailing across global exchanges, in which we’ve all been fed this line of hooey that a massively mediated market is better for buyers and sellers than one with few intermediaries. When in the history of human commerce has it been more efficient to cut the middle man in rather than out?

So the first thing you should do with your volume is multiply it by 35% – the remainder when you factor out automated high-frequency order-matching. So if you trade five million shares daily, the volume to examine is really 1.75 million shares. What’s 12.5% of that – the rational portion? About 200,000 shares.

About 30% of your 1.75 million substantive shares is speculation. Consider it a collection of diverse ways to trade volatility – the exact opposite of relative value driven by programs, because it’s seeking gaps between things rather than correlation among them.

And the remaining 25% or so ranges from hedging institutional positions to wholesale counterparty volume tied to swapping economic interest in things. Bottom line, if you size up what your stock might do on the basis of fundamentals, you’re likely to be wrong. Why? Because 85% of your volume is driven by behaviors for which fundamentals are secondary to volatility or correlation.

And what if you just had a big increase in program trading last week, and now you announce a change in business strategy? This “risk management” volume that just helped your price may depart because of greater uncertainty, eliminating you from sector baskets, funds, ETFs and trading models. That’s not fundamental disappointment, however. It’s managing perceived risk.

When we tell companies what to expect with earnings, we factor in how ALL the behaviors may react to information that is good, bad or about as expected. The result may be much different than consensus. We think of it as the “Market Expectation.”

We pin big blame for these confusing realities on trading markets that aren’t remotely free. See my guest blog for the Securities Technology Monitor last Friday on that topic.

June launched by kicking markets right in the rump. We blamed economic data. It’s true but not that simple. Behind the data at the behavioral level, institutions decided against equities roughly May 13. We don’t make this up, we just observe it in the way trades execute. When methodologies, purposes or time horizons change, it manifests in trade executions.

Money didn’t hedge with options expirations May 18-20 either. If you decide not to insure your house against loss, what might that mean? That you expect to sell it shortly, that risk is nonexistent, or that insurance is too darned expensive. As an analogy, two of those three are negatives and the middle one doesn’t exist on Wall Street.

Here’s another example of behavioral signs. Russell indexes benchmarked against market caps on May 31. MSCI indexes for global quantitative diversification recalibrated the same day. What matters isn’t how they rejigger but what demand is reflected in algorithmic and speculative trading. Demand was terrible. Brokers overestimated demand and so shed excess shares June 1, crushing broad measures.

While bad economic data are a root cause for institutional wariness, it’s not that money woke up Wednesday June 1 and said: “Holy gray underwear, Batman, the economy is lousy!”

Every day, the collective We in the USA and the globe round take various economic temperatures. We watch retail sales reports, oil inventories, speeches by Fed rulers. We check jobs numbers. In our businesses we’re measuring cash flows, sales channels, balance sheets, income statements. We monitor our health with physicals and checkups (We just battered ourselves Sunday riding Elephant Rock).

Why would it be odd to do that with our traded shares? We in IR sometimes pay lots of lip service to market-structure stuff, but we still BEHAVE as though fundamentals are the only price-setting force. The best of the best in terms of rational investment behavior across our client base registers investment at about 16% of daily volume. If you don’t measure data and behavior, you won’t know what’s setting your price.

That’s what we do. We’re sort of the Redbook of stocks, the Fed survey of trading behaviors. We’re assessing different purposes and time horizons behind trading activity to provide a realistic, three-dimensional view of the health of your trading environment, and the role of investment versus noise or risk-management in setting price and driving volume.

By the way, we saw a marked increase in Speculative “over-valued” signals in trading last week for clients. It’s observable mathematically.

We’ll leave you with a scintillating market-structure tidbit. We saw a particular Asian bank program-trading a great number of securities the past three days. It could be that easing done around the Japanese earthquake in which yen were deployed to purchase securities and stabilize markets might now be reversing out.

Behaviors are the best measure of purpose. Life and trading do not happen in vacuums, and the IR pro who knows has a valuable advantage. It’s good to be cool in the IR chair. See you at NIRI!

Sunday night after flying back from Antigua by way of Newark, I reviewed a week’s worth of client stock alerts for perspective. Stepping through a side exit and closing the door on life’s cacophony for a week, time stops. The return, the jolt of the madding crowd, is revealing. It’s amazing what you see.

More in a moment, but I promised some of you I’d share what we saw beyond the Truman Show. Apparently you can’t get from Denver to the French West Indies in a day on one airline, so we overnighted in Newark, touched down in Antigua, caught Eric Air, a fast little twin engine Cessna with a sharp-witted French pilot (Eric) and alighted in Guadeloupe.

Home for a week was a 70-foot catamaran. Our back yard stretched from Petite-Terre to Iles de Saintes, a coral-reefed shot of paradise where I put on scuba gear for the first time. By the looks on our faces off Marie Galante (where I needed a shave), you know we were on the Sea of Tranquility.

Speaking of needing a shave, that’s how the data looked when it slammed me out of the islands upon return. Careening commodities. Whole swaths of clients up and down 2-3% in waves over days. Chunks of erroneous trades, especially in health care stocks. Trend traders and programs for models and funds reversing course May 2 after the VIX euphoria that began April 20.

Seeing it at once was somewhat stunning. Does it mean anything, or is it simply more jarring en masse – like seeing your face after not shaving for a week, in my case? It’s a bit of both. Markets aren’t about to collapse by any means, but these rocking currents, sloshing white caps evident upon farther inspection, are what happens when prices become uncertain.

It may mean nothing ultimately. But a year ago, April 22-27 to be precise, we were telling clients how program traders had suddenly turned fearful. They furled sails and battened hatches with hedges (prices don’t drop then, they…coast). And they were right, as May 6, 2010 showed.

Having reviewed a chunk of data now post Guadeloupe, we see a disconnect forming between enthusiastic investors and cautious risk managers. It’s a buoy in the water for the wise that says there are shoals.

We’re just observers of data. We expect investors will navigate through the reef. But food for thought: Both economically and geographically, Greece is no island. If the Euro skids aground there, it’ll run the dollar up the mast. Stocks are a weight going the other way.

Speaking of fires, we’re marching through them with the Issuer Data Initiative. The Number One Need is more names behind it. If you haven’t committed support for better trading data, do so today. Your peers will thank you someday, and you can remind them then that they owe you.

Before we get to what happened Mar 16-21 in trading markets, a word on BATS Exchange. The Kansas City operator of the third-largest American trading venue has made no secret of its interest in listing companies for public trading. BATS made it official today, announcing plans to offer IPOs another path to global liquidity.

Provided BATS offers competitive listing prices and good data, it can compete. We hope exchange executives will consider the key data points in the Issuer Data Initiative. BATS has a reputation for data excellence already, providing a great deal of free data to its trading clients.

We see too that BATS filed a proposed rule change with the SEC last month that will require customers to mark trades as principal (for their own accounts), agency (on behalf of others) or riskless principal (buying from or selling to a customer). See, issuers? Exchanges file rules to change how things are done. Issuers are participants in markets too. If they want something changed, they too can ask.

What drove trading markets roughly March 16-21 also speaks to the importance of good data. Somebody always must execute the trade and report it. That’s the way we all know the volume for any stock. On March 16, the G-7 countries announced a concerted effort to devalue the Japanese yen by flooding markets with currency. March 16-18 also included the monthly options-expirations cycle, and S&P quarterly index rebalances.

During the same period, we observed uniformity in trading activity for a set of “primary dealers” that work with central banks in the United States, Europe and Japan. Across the market-cap and sector spectrum, the same behavior occurred for this set of primary dealers.

We surmise that central banks armed these large brokerages with cash, which is how central banks engage in “quantitative easing.” The brokerages, also all commercial banks today, deployed it by buying securities from selling institutions. It had the desired effect, stabilizing equity markets and reducing upward pressure on the yen.

We’ve seen that many stocks have returned to their pre-March-10 “rational price” levels. But the behaviors producing those prices aren’t rational. If these were riskless principal transactions, do governments now own a bunch of equities with taxpayer dollars? Or were these all principal trades and so the brokers now have high levels of inventory?

Let’s suppose it’s the latter. Fine, so long as markets rise. Brokers can sell inventory as more buyers return to equities. It’s bad, however, if, say, Portugal defaults, causing the Euro to weaken and the dollar to rise. US equities would slide, and brokers would dump inventory to protect themselves as markets fell.

So everybody get out there and buy something made in Portugal.

A word on trading: We expected money to move after options expirations, but changes to program-trading plans came early, on July 14, we observed in the data. So with expirations July 15-16, markets were shellacked when money shifted to other assets. The past two days have given us massive arbitrage around this shift and ahead of tomorrow’s volatility expirations. Thus, the week could end on a rough note, we fear.

Switching gears, you’ve heard of Direct Edge? It came out of Knight Capital Group and has for many years operated Electronic Communications Networks, or ECNs, called EDGA and EDGX. One was for active algorithms, the other for passive black-box trading systems, in essence.

In 2008, Direct Edge traded Eurex, the operator of the International Securities Exchange, a 31.5% stake for the ISE Exchange. Started ten years ago, it was the first all-electronic options exchange, and it’s one of the globe’s biggest such, offering electronic trading in options for more than 2,000 equities, ETFs, indices and foreign-exchange products. Eurex is itself owned by the German and Swiss exchanges, the Deutsche Borse and the SIX. Direct Edge is partly owned also by Citadel Derivatives, Goldman Sachs and Knight.

With the advent of two new Direct Edge full exchanges tomorrow, EDGA and EDGX, the ISE Exchange will be blended in and discontinued.

Why does this matter to IR? You need to know what’s happening out there. Direct Edge routinely handles nearly a billion traded shares daily. Its platform best serves highly automated volumes in multiple asset classes. It commands about 12% of total equity volume. Its growth mirrors the explosion of global high-frequency trading in equities and other asset classes.

Like other trading innovators, Direct Edge sees growth opportunity in the evolving nature of trading. Both NYSE Euronext and the Nasdaq operate two options exchange each, and midcontinent rival Bats Exchange got approval in February this year for an options exchanges. Direct Edge hopes to offer simultaneous trading in many things – currencies, commodities, stock loans, futures, options, equities.

Why operate exchanges rather than alternative trading systems? It lowers clearing costs, expands data revenues from the consolidated trading tapes (exchanges get a better share than ATS’s), and opens doors to more products for traders.

For IROs, it’s a window into what’s behind price and volume. These are things you have to know now. Markets are fragmented and trading is spread across asset classes. It’s akin to the digital book market. Amazon is now selling more hardback books via the Kindle than in print. That’s how customers are consuming books.

How are customers consuming your shares? One big key to longevity in the IR chair is becoming the source of data and information about trading. We can’t control how traders use liquidity – but we sure can become expert at understanding how it works.

And from that knowledge comes the power to change markets. Or least understand them — and that’s both cool and valuable these days.

Snot Mark is also a tempting description for what’s happening behind share prices and volume, at least at times. But Global Statistical Arbitrage is more accurate, and widespread.

It’s a term that can induce instant narcolepsy too, so we’ll make it interesting. The Nasdaq can be up, the Dow down. Your stock is up, your nearest peer, down. Overnight the Asian markets are up on “renewed enthusiasm,” while by mid-afternoon the following day Europe is down on “rising pessimism.”

It’s statistical arbitrage on a global scale. It can be confused for other things, such as investing, which it is not. Suppose you were buying and selling Robert Graham shirts and doing the same with off-the-rack Macy’s brand clearance shirts. Most times, the price difference between the two asset classes is constant, but slight differences in shirts, fabrics, times of day, and customer interest produce little gaps. It’s on those that you make your money.

To the observer, it would appear that a brisk business is being done. The Robert Graham shirts are really moving and that discount rack keeps clearing out. Ah, but little actual buying and selling is occurring since most times you’re procuring and dispensing the same shirts over and over, with little risk. I’m reminded of what a sharp Israeli client once said, no doubt borrowing it from a time-tested lexicon of smart observations: “We don’t confuse busy with productive.”

Arbitrage often gets people to mistake busy for productive. Arbitrage is the former. Traders weave currencies, futures and options, and global equities into an arbitrage model to capture small, quick price gaps. European banks are doing it. Classic institutional money managers are doing it. Broker portfolio trading schemes are doing it. The catalyst for the explosion of the high-frequency version is monetary intervention over the past two years. It distorts prices – creating a “Trader’s Paradise,” to borrow and twist that old rap song sung by Coolio and penned by Stevie Wonder.

By contrast, arbitrage is risky in markets without price controls or monetary intervention. If there’s no best bid or offer, no mandated one-penny spread between price points, how do you assess your arbitrage risk? You can’t. Yet the Synthetic Market Rip on May 6 is likely leading to more controls, more intervention. Arbitrage opportunity, and therefore risk of another synthetic rupture – if your market is dominated by intermediaries you don’t know its real value – increases. It’s going to happen again.

Solutions are simple. Remove price controls. Expand the supply of currency only when saved capital increases significantly, if at all. That way, the medium of exchange isn’t being used to correct gross failure but instead to match investment capital with opportunity.

And wait! There’s immediate good news beyond simple solutions. One upshot to arbitrage markets is that they winnow some wheat from chaff. We see stark market-structure differences between companies with tight messages and IR outreach adapted to market structure, and those doing the same old things the same old way.

Price is not the measure of solid IR. Sometimes great stories have extended gaps between the rational price and the noise from intermediaries. But real value returns as fulcrum. Knowing what’s productive in your trading and what’s just busy makes you cool in crowds of intermediaries. Alas, there’s a lot of busy right now, and not much productivity. Forewarned is forearmed.

Meanwhile in Manhattan, down on Old Slip between Water and South streets there hums and whizzes a sharp shop of folks whose cares are far removed from the seasons. And apparently geography too, for Hudson River Trading sits just off the East River.

Hudson River Trading (HRT) is a quantitative proprietary trader. What’s that mean, in IR terms? That they use their own money to buy and sell securities with sophisticated mathematical calculations. HRT says it “develops automated trading algorithms using advanced mathematical and statistical modeling techniques and an extremely high-performance computing environment.” In a quick turn of phrase, it claims to have “successfully positioned itself at the intersection of technology and finance.”

Founded in 2002 by a Harvard computer science whiz, a Harvard math star, and the old guy of the group, an MIT math grad from the class of ’97, HRT calls its traders “algorithm developers.” According to job posts, they offer starting salaries around $175,000 plus incentives. They cater in breakfast and lunch. They wear jeans and t-shirts. You can bet these young, brilliant guns work hard.

One of HRT’s bright founders, Suhas Daftuar, has been appointed an interim member director for the new Direct Edge exchanges that will replace the former EDGA and EDGX tapes for active and passive mathematical trade executions. In a 2004 comment letter to the SEC on proposed rule changes emanating from Regulation National Market System, Mr. Daftuar explained that Hudson was a high-volume automated trader providing liquidity.

HRT is a high-frequency trader, not a broker-dealer. It doesn’t work order for clients. It instead does as other liquidity providers do and moves small amounts of liquidity from place to place at lightning speed to fill orders, committing little capital and modulating risk exposure with statistical analysis.

HRT makes money from doing the same thing over and over rapidly in places where it commands a competitive speed or market-structure advantage, and from “rebates,” or payment from exchanges for furnishing shares that attract other buyers and sellers. We’ve explained rebates before.

Key point: there is absolutely nothing wrong with this sort of trading. They are but modern-day specialists meeting the liquidity needs of a transient, complex trading market.

On the other hand, the growth of intermediaries like Hudson River, which facilitates interaction, signals to the observant that markets are commoditized. When intermediaries set prices and determine whether orders meet and fill, there is a fundamental structural problem. Look at health care, where the same problem exists. Intermediaries, not consumers and providers of services, set prices.

We want IR folks to understand that the great majority of trading activity reflects the actions of intermediaries reacting to small amounts of underlying real stuff. Intermediaries don’t determine outcomes, generally. Intermediaries point to changes in market structure. You can’t often fool the fleetest feet in the marketplace.

But intermediaries aren’t here to help you. And intermediaries have shaped the rule structure to which everyone else is now subject. We have equity markets ideally suited to the Hudson Rivers of the world, and they should be congratulated for outstanding entrepreneurial achievement. We in the IR industry might take a cue from them and start offering our own comments on market structure. It’s our marketplace too, after all.

Speaking of which, we at ModernIR have drafted a market structure comment letter for the SEC (the comment period is closing next week). If you’d like a copy, drop me a note. Perhaps you might encourage your management teams to use parts of it and offer comment letters themselves. Rarely do public companies speak up about the equity markets so crucial to capital formation.