Monday, August 22, 2011

Emotional computers and traders

You would think that computer trading programs were not emotional, but what do you call the herd mentality of traders and their computer programs all using similar trading algorithms and software? Using technical analysis patterns such as 'death crosses' to trigger further sales these strategies become self fulfilling prophesies in the absence of retail investors who are spending their vacation time on beaches and beautiful mountains.

Using my playbook to access the National Post's financial pages, I came accross this interesting article titled 'The Madness of Wall Street' by Goldstein et al. published this weekend in various publications. When good stocks fall indiscriminately along poor ones, what else can one call a computer trading free fall than emotional? Irrational? Case in point was McDonald's stock falling 3.6% in spite of a 5.1% increase in same store sales.

The 'Flash Crash' of May 6, 2010 is yet another example of a computer and 'high-frequency' trading strategy induced crash. Research by Strategic Insight - a mutual fund consulting firm, found that in 2009 $85 billion of new mutual fund investment money went into stocks while $425 billion went into low yielding bonds. That is the real effect of this computer induced high market volatility.

High frequency trading destroys investor confidence; it drives the small investor saving for retirement, out of stocks. It keeps large investment pools on the sidelines because of unpredictable returns and ultimately this will reduce stock equity as a viable source of corporate investment capital. It will, in the extreme end, destroy the stock market and the publicly traded corporations. The few spoil the benefits of stock markets for the many.

In the meantime, I hope you have controlled your urges to sell and instead nibble at cheap market indexes such as the Dow Jones Spider (DIA). Use short term volatility to buy long term holdings at the right price.

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