You don't have to be a sci-fi movie expert to know that when humans and machines clash, things usually go poorly for the flesh-and-blood faction. Just think back to The Matrix (the first one, not those god-awful sequels) to see what I'm talking about.
So you can imagine my concern when I learned that perhaps as much as two-thirds of daily equity trading volume is the result of orders placed by -- you guessed it -- machines.
Rage against the machines
According to a recent Wall Street Journal article, "the majority of stock trades now originate with fully automated 'high frequency' funds." These funds "trade in and out of stocks at light speed without human intervention," making a minuscule profit on each transaction. This is all made possible by market centers like the New York Stock Exchange, which pay these high-frequency funds a tiny rebate for each filled order in order to facilitate liquidity.
That might not sound like much of a strategy, but it becomes quite lucrative when you jack up the trading volume. And apparently, that's exactly what high-frequency funds have done over the past year and a half.
Proponents of high-frequency trading claim that the heavy volume helps keep bid/ask spreads low, helps buyers and sellers find a mutually agreeable price, and reduces price volatility. However, a report from Themis Trading blames high-frequency trading for skyrocketing stock market volatility.
That's consistent with the WSJ article, which claims that "with the rise of these automated funds, the stock market is more prone than ever to large intraday moves with little or no fundamental catalyst."
Now before you start smashing your kitchen appliances, bear in mind that machine-based high-frequency trading wasn't solely responsible for those large intraday moves.
While it's far more convenient to place the blame on fast-trading machines, we can also thank hedge fund deleveraging, mutual fund redemptions, and a panicked (human) investor populace for the astonishing market volatility over the past 18 months.
That's right, I said thank
You see, while short-term stock price volatility can be tough for our all-too-human emotions to handle, it can also create tremendous buying opportunities for long-term investors. That's what Lord Abbett senior economist Milton Ezrati reported in a paper called "How to Stop Worrying and Learn to Love Volatility."
According to Ezrati, regularly adding new money in a volatile market allows an investor to purchase more shares at cheaper prices, thus lowering the effective cost basis. Interestingly, Ezrati's findings hold true whether prices are rising or falling.
Where the volatility is the worst
Take a look at the share price fluctuations for these steady, stable companies over the past 52 weeks, none of which have had significant fundamental issues:
Company
52-Week Share Price Range
Peak-to-Trough Decline
3M (NYSE: MMM)
$40.87 - $74.71
45%
Colgate-Palmolive (NYSE: CL)
$54.36 - $80.49
32%
Coca-Cola (NYSE: KO)
$37.44 - $55.84
33%
ExxonMobil (NYSE: XOM)
$56.51 - $84.76
33%
Whether they're because of machine-originated trades or not, those are some pretty serious share price drops for companies of this caliber. But that volatility is nothing compared with the shifts seen at the smaller end of the market-cap spectrum.
Company
52-Week Share Price Range Continued... |