Investors Should Ignore Knight Madness

Posted on August 10, 2012 at 11:54 AM PDT by

Another day, another fat-fingered mess on the trading floors of Wall Street. Meanwhile, stock-holding-period madness reigns, due largely to robot-driven trades . Who’s driving this crazy train?

Consider some of the recent “news” in the markets: Knight Capital KCG -6.26%  wallows in the aftermath of technical trading glitches. The Facebook IPO disasterrages on. Morgan Stanley has its own headaches, largely technical , related to a merger from 2009.

And now this amazing observation regarding the competing, and sometimes conflicting, software systems running our markets.

From Reuters : Regulators have set up “circuit breakers” that require exchanges to suspend trading in stocks that move too much too quickly. But dealers and other market players usually have even more sophisticated circuit breakers for their own trading.

“You need an algorithm to monitor the trading algorithm,” said John Bates, chief technology officer at Progress Software, which provides trading software.

Read that again slowly. An algorithm to monitor an algorithm. It is kind of hard to believe that is a real quote.

Jack Bogle had this to say, in an interview with CNBC , regarding the right stockholding period and the Knight Capital debacle. Put simply, don’t sweat it:

“For speculators, these kinds of events are really momentous in their implications. On the other hand, I look at long-term investors, who should look at this whole thing and, believe it or not, give one great big yawn.

“If you’re investing for a lifetime, let’s say in a market index fund owning every stock in America , it is meaningless. It shouldn’t disturb you at all. It should remind you of how smart you are to have done what you did.”

Bogle continued. In the long run, investing has nothing to do with the stock market, he explained. It is owning companies. The market, he said, only subtracts from corporate returns over time.

We agree heartily, of course. The really shocking part about the recent trend toward high-speed, computer-driven trading is just how extremely short the average stockholding period has become. One study found thatinvestors now hold stocks on average about five days . Back in the 1960s, the average stockholding period was eight months.

Putting the stockholding period in perspective

Imagine the inner workings of a typical large company. Thousands of employees, hundreds of suppliers, hours upon hours of meetings. Software crunching up data, trying to figure out if sales in Southeast Asia might, maybe, rise enough to offset a sales dip just reported in Europe.

Do you think that company will react, adjust course, and make a decision inside a working week? Absolutely not. It will take a solid month to decide what color shirts to order for the annual picnic.

Yet, on average, in less than a week that company’s stock has already traded hands, maybe more than once, based on absolutely nothing. As Bogle says, you’re better off owning the whole market and rebalancing long after the dust settles.