Hi John,

I really appreciate you letting us know how you were affected by the
recent chaos in the markets. I think a lot of people's stop losses
were triggered by the events of the day.

One of the things that I don't like about the explanations I've been
hearing is that "algorithmic" trading (algo trading, high-frequency
trading, etc.) is to blame. A stop loss is a computerized trading
algorithm, which has been used for decades. It's important to put
that algorithm in the context of any market meltdown. Stop losses
work as you would expect when thinking about an single position. No
one is talking about eliminating them. Yet, stop losses are no doubt a
factor in market crashes, of all kinds.

Another thing that I don't like is blaming "rogue traders" for making
bad trades and crushing the market. People make mistakes all the
time. It's part of being human. What we have come to expect, though,
is that the millions of people who make up the market are infallible
en masse. That the market will somehow magically correct when a
"rogue trader" makes a bad trade. The Black Swan by Nassim Taleb
explains why events like this are what we have to prepare for.

Malcolm Gladwell's books Blink and The Tipping Point also explain why
the markets go haywire. The first problem is explained in Blink:
People do not make reasonable decisions under pressure, especially
within the first few seconds of a high stress event. Second, once
enough people make poor decisions, the market "tips" over to a new
state. At that point, stop losses trigger (and other automatic
trading algorithms) and herd mentality takes over. And, people panic.

One of the things I really like about investment clubs is that they
can't trade in a panic. There are no emergency meetings in the
boardrooms of investment clubs. If the government wanted to help
individual investors, they would force them to invest in a club before
going out on their own. That's not going to happen, of course.

This wasn't necessary in the days of yore, when the markets were
buffered by the slower communications media of the time. (Remember
reading stock prices the next day in the newspaper to see how your
portfolio was doing?) A century or so ago, people in the US got
around by walking or public transport. Today, people drive cars and
you are required to have a license to drive. A similar thing has
happened in the financial markets, but the regulatory mechanisms which
would help us adapt to the speed of the new technology aren't there.

I'm not a big fan of government regulation, however. I don't think
the government has a clue how to invent appropriate market
stabilizers. They do have "licenses" for brokers, but the tests
required cover the technical/legal aspects to protect consumers. They
obviously aren't doing anything to stabilize the markets. Indeed, I
think many consumers got burned this week, while the "professional"
traders probably were able to get the worst of their trades reversed.

The lesson for me is that I don't watch the markets every day. I
avoid any type of automatic trading (e.g. stop losses or options). I
look for quality companies and sit on them. Yes, there will be the
occasional Enron, but then you might also buy a company like Apple.
In all cases, my investing horizon is years, not weeks, hours, or
milliseconds. This type of investing takes an even keel and a strong
will. It's very tough to watch a stock drop by 25% even though you
know none of its fundamentals have changed.

Cheers,
Rob

>It's very tough to watch a stock drop by 25% even though you
> know none of its fundamentals have changed.

It's tough, but fortunately, in this community, we also know this can be kind of exciting. It
probably
means there's a really nice sale going on and it's time to go shopping.

:)

 Laurie Frederiksen