Volatility is the Investor’s Friend

Apr 2006

Program trading is technically defined as the purchase or sale of “baskets” of at least 15 stocks worth at least $1 million.  In more practical terms, program trading sometimes seeks to exploit small—and frequently temporary—differences in stock prices.  As you might infer, program trading has very little to do with long-term reasoning.  Stock price moves caused by program traders, therefore, are normally uncorrelated with long-term economic reality.  Soooo . . . what amount of trading on the New York Stock Exchange (NYSE) do you suppose is accounted for by program trading?  Is it 5%?  10%?  Would you believe that over half of all NYSE trading is the result of program trading?  Amazingly, this is the case.  Given that a majority of stock trading is based on very short-term factors, not on long-term fundamentals, is it any surprise that short-term prices exhibit significant volatility?  As unsettling as large stock market moves may seem to some, successful investors just don’t worry about volatility.  Instead, they use it to their advantage by buying when a stock’s price temporarily becomes unreasonably low.  Then they practice patience and eventually sell at a reasonable price—or perhaps even an unreasonably high one. Volatility is the patient investor’s friend.