Dave Sather's Money Matters: Battling the 'bots

It happened so fast; unless you were staring right at it, you never saw it. However, one of our clients, Ted, was watching.

He called our office in a matter of minutes trying to determine if he was imagining things - or, had the market truly dropped 140 points and then recovered all in a matter of seven minutes?

Ted's observation was accurate.

As we discussed the odd trading behavior, news stories about a fake Twitter post surfaced reporting a bombing at the White House with the president being injured.

Although it was a hoax, the moves in the financial markets were real.

Ted was inquisitive. How could this happen so quickly? What were the implications to his portfolio, and how do we protect ourselves from an incident of this nature?

Computer algorithms constantly search the Internet for news stories focusing in on key words. It could be something as broad as the economy or as focused as manufacturing operations at one specific company.

These data bits are then scored with that information feeding into trading programs. The fully automated trading programs then kick in, placing buy or sell orders (or both). All of this happens in a matter of milliseconds.

As I told Ted that this happens in a blink of an eye, he asked how can anyone possibly "outtrade the robots?"

Ted's observation was a good one. There will always be a faster computer, and there are physical limitations to how quickly you can receive, process and act upon information. Additionally, it helps to remember that markets are made up of emotion-driven speculators as well as logical investors. Just because someone makes an irrational or emotion-based decision does not mean a logical investor must chase after them or even react at all.

Furthermore, the volatility from immaterial news or irrational speculators does nothing to change the long-term value of a company. This bombing hoax has no impact on sales from H-E-B, Budweiser or Wal-Mart.

Knowing this, a logical investor will recognize this for what it is and either sit tight or take advantage of the emotion-driven irrationality of others.

As Ted began to see my point, I added that people who function in the financial markets need to know whether they are "traders" or "long-term investors."

Traders are constantly moving in and out. Not only does this increase commissions, but it also decreases tax efficiency. With automated trading, volatility can irrationally spike in an instant. Unfortunately, the long-term rates of return do not reflect wisdom in this practice. Knowing this, we focus on long-term investing.

Whether we buy one share or 1 million shares, we behave as if we own the whole company. We own a company because of the long-term value created from its operations and profitability.

As I said this to Ted, I asked him if he owned all of Exxon, Coca-Cola or Wal-Mart - would he day trade them for fractions of a penny? Ted laughed and said, "Obviously not."

From our perspective, the thought that you can out-trade the market is simply a casino-type mentality. It does not work.

It is so much easier to focus on understanding the financial statements of companies and invest in good quality companies for very long periods of time.

Warren Buffett has often said you should only choose investments you'd be happy holding if you were stranded on a desert island for the next 10 years. Adopting that philosophy helps to focus investors on the long term - and ignore the "noise." Combining a long-term focus with discipline and logic allows successful investors to focus on the issues that matter most.

Dave Sather is a Victoria Certified Financial PlannerT and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.