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Man Vs. Machine: Commentary—How You Can Beat Computer Programs


As you read this blog, a computer somewhere just made thousands of trades in less than a second. Not just less than a second, but we are talking about execution in less than 300 microseconds or a 1000 times faster than a blink of a human eye. Speed in trading has taken on a whole new meaning in the past couple of years.

In 2006, trades executed in one thousandth of a second, or millisecond, were considered high speed trading. Now it's executed in microseconds.

Computerized program trading is nothing new, but the frequency of computerized trades has changed the investment game. In an age of supercomputers, investing has given way to trading. In a sense, traditional fundamental analysis is of secondary concern for high-frequency computerized trading strategies. Instead the overall goal is to find anomalies in pricing and to capture perceived opportunities immediately. Arbitrage strategies can occur in a matter of milliseconds and computerized trading seeks to capture these price advantages.

Over the years, the game has changed, and you need to know how it affects you and how you can cope with this new reality. Short-term strategies executed by supercomputers have increased trading volumes across all stock exchanges, leading to a greater volatility on a day-to-day basis.Currently high frequency trading represents more than 60% of trading activities in the U.S. equity markets; and represents 75% of all equity trading volume in the U.S.

One only needs to look at the wild swings that occur for seemingly no reason to see that computers are the mischievous moles that are impacting the stability of markets. Take a look at the recent fluctuation during the flash crash in shares of Proctor & Gamble . It's hard to explain these market movements on anything else but computerized trading.

Bold individual investors continue to be tempted by the attraction of short-term trading, but it is clear that technology has now made this an even more difficult strategy to embrace. It's you against supercomputers cranking out data calculations in milliseconds. It's an unfair fight and one that needs to be addressed by regulators. But for now it is what it is. The playing field is not level unless you have the technology and resources to compete.

It's our view that one can never completely eliminate technology as a potential competitive advantage. But limiting the ability for computer-based trading to massively move markets based on quick and often times temporary bets is a good start.

However, it is probably far down the road before any action is taken. Computers are here to stay, and therefore investors need to adapt to this new environment. How can the individual investor cope and compete?

Surrender is in order if one is trying to compete with banks of supercomputers on a short term basis. Now, more than ever, investors need to be focused more on the underlying thesis of an investment strategy. A combination of fundamental and technical analysis makes sense.

By adopting this strategy of fundamental analysis, investors can conduct research and analyze companies that will potentially yield mid- to long-term profits. This is an area where supercomputers are still not quite so, well, super. It's where the playing field is a bit more level than the day-to-day fluctuations that wildly impacts market stability.

Use your mind and insight. It still beats the the computer in long term analysis. That's where you will keep your edge as an investor.