I Think, Therefore I Am Not a Computer

A look at how computer-driven trading influences wild market swings, helping individuals get in when the market is cheap

Rodney Hobson 7 September, 2012 | 12:28AM

I think, therefore I am not a computer. I can look round problems, as computers cannot, and I don’t panic as computers do. Long live the human investor!

No one knows how many stock market trades are generated by computers making decisions for humans (as opposed to humans telling computers to buy or sell) but the best guess is that at least 60% of buy or sell orders are now computer generated and that possibly as many as 40% of bargains are struck between computers acting for both sides.

Some people think this is a cause for panic as computers take over investment. On the contrary, it opens up more scope than ever for human investors. Don’t panic. That is what computers do.

The key fact is that computers are often on both sides at the same time. Yes, one computer is screaming sell at the same time that another computer is desperate to buy. So why would anyone think that computers have any more idea about investing than human beings?

Some people think this is a cause for panic as computers take over investment. On the contrary, it opens up more scope than ever for human investors

Human beings have different needs and investment criteria so it is perfectly reasonable that they should be on opposite sides of the fence. But computers are just programmed to make the most of the short-term situation and in theory ought to be taking the same decision. Computers are geared up to act, which means they are likely to trade rather than sit on their hands. Hence the phenomenon we are now seeing of markets swinging widely when the computers decide to be all on the same side. The corollary is that every lurch downwards brings out an array of computers rushing in to buy, sending the market spiralling upwards.

Sometimes markets do move strongly in one direction or another because of economic news. At other times there are sharp movements for little or no reason. This week was a prime example of the latter and I suspect that computers were to blame.

One may accept that uncertainty over the Spanish debt crisis unsettled markets earlier in the week, but why such a sudden drop in share prices on Tuesday and then a bumpy ride on Wednesday, when the situation was really no different from what it had been in weeks past?

Bond yields in Spain and Italy actually fell on Wednesday, with talk that the European Central Bank (ECB) would buy three-year bonds and create more breathing space than expected. The bond market already seemed to be counting on a better outcome at the same time that stock markets were taking fright.

The stock market did not catch up until Thursday, when yet another time-buying fudge that does not really address the underlying issues was announced by the ECB. The funds that will buy bonds are still conditional on individual European governments coming to heel.

The position today, last week, last month, last year is the same: the euro will struggle on and every desperate measure will be used to hold it together in its entirety.

OECD was Overlooked

Far more significant, and ignored by the markets, was news of a downgrading of economic forecasts by the Organisation for Economic Cooperation and Development (OECD). The UK came particularly badly out of the revision and the OECD is now saying that economic growth in the second half will come nowhere near to wiping out the contraction so far. That is itself is not a great surprise, but the overall forecast of a 0.7% shrinkage, compared with an earlier forecast of 0.5% growth, is pretty drastic.

Stock markets here and abroad continue to swing wildly without real justification for the moves. Once more the opportunity presented itself for investors to buy on the dip and show an immediate profit

The rest of the European Union has also been downgraded and is blamed by the OECD for weakness in the global economy. Even the US was tweaked downwards, though it remains a shining beacon in the western world. (I will be commenting on the US situation in a video for Morningstar shortly.)

Let us, though, return to the main message. Stock markets here and abroad continue to swing wildly without real justification for the moves. Once more the opportunity presented itself for investors to buy on the dip and show an immediate profit. Computers will increase the number of times this happens going forward.

Market Performance (September 3 - 7)
FTSE 100: +1.46%
FTSE 250: +3.49%
FTSE All Share: +1.55%
FTSE Small-Cap: +1.42%
FTSE AIM 100: +3.49%
FTSE Fledgling: -0.18%

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Rodney Hobson is a long-term investor writing about his own portfolio; his comments are for informational purposes only and should not be construed as investment advice.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, most recently The Dividend Investor.

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