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Yoshikami: Computers Are Killing Investors

It's a roller coaster ride. Markets up and down with no rationale that easily explains the fluctuation. Yes, the US is in a stumbling recovery and Europe is a major problem. But the sheer magnitude of the volatility has left many investors shaking their head and seeking to abandon investing in any market related assets.

So what's causing this volatility? It's very simple really; technology. Information and the ability to react at the blink of an eye has changed the game. And for individual shorter term investors, it's now an unfair playing field.

In the good old days when paper reports and discussions drove market performance, there was time to digest and ponder investment decisions. That is no longer the case; technology has changed the game. Just look at trading in companies like HP and Citigroup . These companies have fluctuated up and down based on fundamentals but volumes suggest that computerized trading is driving the beta on these stocks.

Traders work on the floor of the New York Stock Exchange
Getty Images
Traders work on the floor of the New York Stock Exchange

The internet has created a more level playing field but has resulted in the ability to react instantaneously.

And not only individual investors are prone to rapid movements based on released data; institutional investors are as well.

With the advent of supercomputers, there are banks of hard drives whirring away in the background attempting to capture a price anomaly on a second by second basis. Literally thousands of trades can occur in a one second timeframe and, when you have many institutions and computerized investors employing a similar technique, the whipsaw in the market can be staggering.

One might think that trading fluctuation is merely a reflection of fundamentals; that is simply not true. Yes, fundamental data points and news stories do significantly drive markets, but the intensity of the movement is multiplied exponentially by fast acting computer programming. So what might have been a 75 point drop in an equity index can easily turn into a 300 point drop if thousands of computers simultaneously hit the panic button based on a short-term technical indicator. That's what we see happening today.

Many investors sold in 2008 when the economy was in dire straits and computer trading exacerbated the situation. "I simply cannot take the volatility" many exclaimed and that is completely understandable. Of course, what they did not recognize was that the volatility was directly related to computerized trading. Just as quickly, when sentiment shifted, the other direction computer programming took over and we saw a historic rally upward which many investors missed. So, in an era when volatility is at high level, one has to make a determination about time horizon and how much short-term anguish can be endured when the computers kick into overdrive9

Banks of computers or driving investors out of the market and it's simply not right. I have been a proponent of the perspective that the playing field must be leveled and individual investors without millions of dollars to pour into computerized trading, should be given the same opportunity for success as big institutions. But while I believe this is important, I doubt significant action will be taken.

I'll let you draw your own conclusions on why that might be the case.

In the meantime, time horizon assessment is what's key. If one is a short-term investor trying to compete with technology far superior to anything mere mortals can afford, one should really rethink the investment strategy employed. The reality is it's a new world for investing and understanding the landscape is critical because the environment has changed permanently.

Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at YCMNET Advisors. Founded in 1986, YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009 and 2010. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.