President’s Corner – The Moment’s Over

After Ebby Calvin (“Nuke”) LaLoosh (played by Tim Robbins) pitched a perfect inning for the minor league Durham Bulls baseball team in 1988’s Bull Durham, he sat next to his catcher, Crash Davis (played by Kevin Costner), and they had the following conversation:

Nuke : That was great, huh?

Crash : Your fastball’s up, your curveball’s hanging. In the Show, they would’ve ripped you.

Nuke : Can’t you even let me enjoy the moment?

Crash : The moment’s over.

“The moment’s over” is the way many investors feel about now. After an unprecedented bull market following the worst economic downturn since the Great Depression of 1929, the stock market came crashing down faster than an old Las Vegas hotel. During one February week, almost $1 trillion of market value was wiped away.

The usual self-described stock market gurus showed up on every news and business channel to give their reasons for the “market correction.” Some of the reasons given included major shareholder selling, negative economic news, high profile corporations failing to meet unofficial estimates (referred to as “whisper numbers”), declining Gross Domestic Product, revised tax policy, a new administration in the White House, and impending armed conflicts around the world.

There have always been short-term spurts of wild variances in the market, but at no time have we seen more of these wild highs and lows in the history of stock trading. The biggest factor that few talk about is automated trading systems. These systems allow mostly institutional traders to establish specific rules for buying the selling stock automatically executed via a computer. When a stock price gets to a certain price or a technical indicator reaches a specific level, the automated system will simultaneously trigger a trade.

The main advantage to such a system is that it minimizes emotions so that the trader cannot hesitate or question the trade. Secondly, the systems are consistent because the computer is executing the programmed trades. Thirdly, the order entry is made at the same time trade criteria are met, minimizing possible trading losses. Finally, the automated systems can spread risk over various investment instruments while creating a hedge against losing positions. This would be incredibly challenging for a human to accomplish this level of efficiency in a matter of milliseconds.

The biggest disadvantage, other than mechanical failures, is the oversubscription of programmed trades. In other words, if too many trades are automated, it creates larger and potentially more volatile swings in the market as we have recently experienced. According to Wikipedia, as of 2014, more than 75% of stock shares traded on U.S. exchanges originate from high-frequency programmed trading system orders.

That seems like a very big, to the point of being unwieldy, number. For those 25% who trade the old-fashioned way, well, the moment’s over. By the time those trades are made, the market will have significantly shifted. That shift could mean the difference between trading at a profit or at a large loss.

The Financial Industry Regulatory Authority (FINRA), which regulates stockbrokers, and the Securities and Exchange Commission (SEC), which regulates publicly held companies, have instituted some restrictions of automated trading to minimize market fragility and volatility, but more needs to be done to keep up with the advancing technology in this area.

One simple thing average investors can do to minimize their downside risk is rather than invest in individual stocks, they can invest in mutual funds that already utilize programmed trading and automated portfolio rebalancing which is simple and effective. These steps can help reduce the “The moment’s over” time by at least a few moments.

David M. Green
President/CEO
(925) 335-3802