If This Scares You, You Shouldn't Be Investing

There are a lot of things to worry about as an investor. Hackers aren't one of them. 

Last week, hacker magazine 2600 described what a potential cyber attack on global stock markets could look like. It wrote (via Business Insider): 

Now imagine this attack scenario. Agents of an enemy of the United States successfully break into the mainframes of a High Frequency Trading Company, Dark Pool Crossing Network, or Brokerage Company. They infect the system with rogue trading algorithms or change the code on currently deployed algorithms. In a single coordinated attack, they buy and sell millions of shares of a single company or multiple companies, causing trading to halt or decimating the value of a single stock. Multiply that by 100 stocks of the top Fortune 500 companies and we have market collapse. Trading for the day would halt and uncalculated economic damage would be done.

Scary stuff -- until you get to the last sentence, which tiptoes into the absurd: "Uncalculated economic damage would be done."

Stop, stop. No, it wouldn't.   

The market is a thermometer. If your thermometer breaks and says it's 300 degrees outside, it isn't actually 300 degrees outside, and no one will actually burn to death. This is obvious when thinking about temperature, but it becomes easy to forget when thinking about stock prices and the businesses they measure. Money is just emotional like that. 

To assume a hacker-driven market crash would cause vast economic damage, you have to assume that day-to-day stock prices have an influence on the businesses they represent. But they do not. It's the other way around -- the underlying businesses are what drive stock prices. In a hacker attack, Coca-Cola stock might temporarily fall to $0, but Coke isn't going to stop selling Coke, the bakery won't stop selling bread, and brick layers won't stop laying bricks. Things would get real itchy on Wall Street exchanges, but broad business values and economic activity wouldn't change an inch. 

Last week, the Nasdaq experienced a technical snafu that halted trading in all the stocks listed on its exchange for three hours. What impact did it have on the economy? Nothing, really. A few Nasdaq executives might lose their bonuses, and a few day traders might have been left hanging. The economic damage of both was likely offset by journalists having something new to write about.  

We don't have to guess what an attack shutting down the stock market might do to the economy. We've experienced it. U.S. markets closed for six days following the 9/11 terrorist attacks. And while the actual terrorist attacks affected all kinds of businesses -- airlines and theme parks and such -- I can't think of a good argument for why keeping the market closed for a few days led to a measurable drop in economic activity. After the Flash Crash of 2010 sent the Dow Jones down 1,000 points before rebounding, a group of Motley Fool writers set out to find anyone -- investors or otherwise -- who had been negatively affected by the incident. They couldn't find one. Most investors didn't even realize it happened until long after it was over and stocks recovered. Of course, most people aren't concerned when the market remains closed every Saturday and Sunday. It causes no problems for the same reason a hacker crash would have no direct impact on economic activity: There is a vast difference between stock quotes, business values, and economic activity. 

One of the most fundamental traps investors fall for is not realizing the difference between business values and stock prices. Business values are driven by human ingenuity, creativity, brand awareness, patents, contracts, and ideas. Stock prices are just short-term quotes on what other people are willing to pay for those assets at a given moment. When you conflate the two, you become a victim to the stock market's ups and downs rather than a beneficiary of a business's profits. 

Cyber attacks could wreak havoc on the economy if targeted at actual commerce: Supply chains, energy pipelines, or payment systems, for example. That's what people should worry about. But as Warren Buffett says, you should buy companies you'd be happy owning if the market shut down for the next decade. Bring it on, hackers. 

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 


Read/Post Comments (30) | Recommend This Article (84)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 27, 2013, at 10:57 PM, RedandBlack wrote:

    I would love to have the market closed more often. Less day trading, less ticker scrolls, less people talking on CNBC, less obsessing over every little stock move.

  • Report this Comment On August 27, 2013, at 11:33 PM, Risky88 wrote:

    this is one of my

    FAVORITE article ever written

    period!

    heaven forbid the world use common sense

  • Report this Comment On August 27, 2013, at 11:53 PM, 123spot wrote:

    Simply great. Thank you. Spot

  • Report this Comment On August 28, 2013, at 10:22 AM, alexf wrote:

    Wonderful article and right on.

    As for @RedandBlack, I'm with you. Sometimes trading should take a break when market silliness takes over.

  • Report this Comment On August 28, 2013, at 3:02 PM, SkepikI wrote:

    A rational and economic/business theory medium term correct article. I am reminded of the flash crash wish I had that I knew about it while the market was still down so I could buy, but like most, found out too late... ; -)

    I wonder, however, Morgan if you underestimate the debilitating long term effect that such an event would have on the "trust" of investors. Particularly if it is "reproduced" at some future date. Destroy the underlying confidence in capital markets, and maybe the ability to do a Faceplant IPO gets destroyed as well (oops countered my own argument, ha)

    Perhaps a semi-permanently repressed stock market, similar to the semi-permanently repressed bond market we have now rewards participants by outsize dividends while prices languish. However things proceed, the generic idea that business success will be rewarded somehow is reasonable, but the generic idea the market won't suffer some long term distortion seems irrational to me. Still, the kind of useful and interesting think piece or maybe prognostication (lets hope not) I have come to expect from Morgan H.

  • Report this Comment On August 28, 2013, at 3:10 PM, TMFHousel wrote:

    <<I wonder, however, Morgan if you underestimate the debilitating long term effect that such an event would have on the "trust" of investors>>

    I thought about that, but quickly realized we have three good templates to show the impact on confidence: The 1987 crash, 9/11, and the Flash Crash. I haven't seen evidence that any had a lasting impact on investor morale.

  • Report this Comment On August 28, 2013, at 3:26 PM, milfalcon wrote:

    Well, the flash crash hurt me. And taught me to never use stop-loss orders while the environment seems susceptible to having another flash-crash (which seems like always now). It's frustrating when you don't want to monitor your stocks every day, so you had stop-losses on them (originally at 25%, though some of their margin of safety had been lost before the flash crash), then they crash, the stop-loss activates, and the prices recover before you can do a damn thing. It didn't turn me into a pauper by any means, but I sure wish I had that few thousand dollars back!

  • Report this Comment On August 28, 2013, at 5:00 PM, jmu1986 wrote:

    Oh it would have an effect on the market you bet it would. The retail guys would be wiped out ! Imagine the wealth wiped out in a matter of hours? Nice article but it would do more damage. What would be next, the electric grid?

  • Report this Comment On August 28, 2013, at 5:10 PM, AnsgarJohn wrote:

    Yup.

  • Report this Comment On August 28, 2013, at 5:35 PM, kingfish100 wrote:

    I don't think you tried very hard to find no losers due to the Flash Crash of 2010 because I, a multi-year subscriber to MF lost because of trailing stop loss orders and I've got to believe there are many like me. With what I thought was protection=stop loss orders, I had several large positions sell as instructed via 20% drop trailing stop orders then rise back to or above their selling price after the crash came back up. My "protection" in these cases cost me 20% in every position for which I had a trailing stop order. Am I in position now to recoup losses from this error beyond my control? How could you not find people in similar situations to me?

  • Report this Comment On August 28, 2013, at 5:47 PM, nwaluli wrote:

    I really do enjoy reading your articles and look forward to the ones you author. This piece on the stock market crashing is especially eye opening for me because it makes a lot of sense. Business will indeed keep going if their stock is not able to be traded on any exchange and even if the market closed down permanently, someway would be developed to determine where all the shares were held. It would be a heck of a mess but it would be figured out.

    I would be very interested in hearing your take on "what if hackers were able to infect the US banking system and money in individual accounts were not accessible and customers were not able to get their money". I get very concerned when I read about hackers being able to stop a bank from functioning because the hackers were able to infect the banks computer systems.

  • Report this Comment On August 28, 2013, at 6:20 PM, hbofbyu wrote:

    Banks and Credit Unions do a daily back up of all member data and transaction files that are saved for at least 7 days and usually 30 days. With memory being so cheap now they may have daily files stored for more than a year. A hacker nor virus can destroy your bank account.

    A worse scenario is no power. But most prepared businesses have generators.

  • Report this Comment On August 28, 2013, at 6:55 PM, iamkilaru wrote:

    If big investors lose money in a hacker attack it can deprive funding for many businesses.... and can definitely cause some real economic loss. It is not entirely like a broken thermometer....

    One reason for people to invest in stocks and bonds is its liquidity + higher than bank deposit returns. If the markets become prone to hacker attacks.. fewer people will be willing to invest in stocks/bonds... if the liquidity in secondary market goes down it will lead to lower investments in IPOs and that leads to funding scarcity affecting economic activity... again it is not like a broken thermometer...

  • Report this Comment On August 28, 2013, at 8:42 PM, kyleleeh wrote:

    As they have been mentioned by several people in this thread:

    Stop loss orders= Not only do I buy high and sell low, but I'm too lazy to do it myself.

  • Report this Comment On August 28, 2013, at 9:27 PM, ziq wrote:

    @ iamkilaru: that was exactly my first thought. Businesses that rely on the ability to borrow money might be hampered. But it's not something I'm going to lose sleep over.

    A better analogy to a thermometer might be something like the Dow. A thermometer is looking at average behavior of molecules in its environment and is of necessity part of that environment. Usually a negligibly small one, though.

  • Report this Comment On August 28, 2013, at 10:22 PM, TruffelPig wrote:

    Good article! That is correct what you write but market crashes can be a bit unnerving. Agree with the commenters on stop loss orders - money out of the window........very difficult to time buying well. Better to scale in or buy and forget about it for a long time until idea works out or not.

  • Report this Comment On August 28, 2013, at 10:28 PM, JadedFoolalex wrote:

    " I am reminded of the flash crash wish I had that I knew about it while the market was still down so I could buy, but like most, found out too late... ; -) "

    All trades both down and up were cancelled as per SEC rules so you wouldn't have gained anything. As for those of you who used stop-losses to supposedly "protect" your investment, I believe you now know that stop losses do absolutely NOTHING to protect you! Think of the elephants (Institutional investors, pension funds, ETFs, etc. etc.) storming for the exits all at the same time. Do you really think your paltry thousand shares matter? Your stop losses might have activated at 20% down. In a real crash, you would have lost it all!! So you have been given a several thousand dollar lesson in what NOT to do. Stop losses do not work, period. So find good stocks and just let them ride, IF you are an investor. If you're a trader, good luck to you, gentlemen cuz you'll need all that you can get!

  • Report this Comment On August 28, 2013, at 10:53 PM, shenoy2206 wrote:

    Nice article Morgan as usual.

    I am one of those who actually benefitted from the Flash crash in May 2010. When I saw the market go down I put in buy orders for some stocks from my wish list like NFLX at 90$ (when original trades that day were in 125$ range).

    It was good for me though as I used that opportunity to make some good buys by pumping in more of my savings. 2010 stock market correction is a major reason why I am doing very well today in my stock Portfolio

    Having said that such crashes do impact business sentiment, investor confidence. In fact after the flash crash in 2010 the stock market VIX spiked and the stocks went through a severe correction from June 2010 till Sept 2010.

    Most folks would attribute it to Famous Wallstreet adage "Sell in May & go away". BUT, I think the Flash crash was a major reason for that market correction.

    So my thoughts - Flash crashes does have impact on business and economic activity atleast over the short term

  • Report this Comment On August 28, 2013, at 11:57 PM, Stuartrudd wrote:

    If the value of your house dropped 90% overnight, would you panic sell in the morning to anyone willing to buy it?

    Where would you live then?

    No. You would wait and let the value recover. You would understand the importance of its function and that buying it wasn't only about equity growth in the future. It also sustains your life. You can't put a value on that and you still need the house during the price drop.

    The MF mantra has always been about buying business not stock. As long as the business will stand back up after the knock down, then it should be ok.

    Also - a stop loss order in my house analogy is the equivalent of a robot agent selling your house and throwing you out in the middle of the night while you are sleeping :)

    Surely you would prefer to watch the Phoenix fly from the flame?

    Lastly - value of houses are set by agents who have no professional qualification. Why do we let them dictate the market? No, a house is worth what you are willing to pay for it. Can you see my parallels here...??

  • Report this Comment On August 29, 2013, at 1:12 AM, jordanwi wrote:

    Wait, wait, let me get this straight Kingfish: You set up a stop loss for when the market tanks. The market tanks. You're saying that you've been damaged?! You initiated the trade! What else was it for? You took a VOLUNTARY 20% haircut, I'm sorry.

  • Report this Comment On August 29, 2013, at 4:24 AM, gsemlak wrote:

    What happens if customers' portfolio files are corrupted in an attack? How can they be restored, and how long would it take to restore millions of individual files?

  • Report this Comment On August 29, 2013, at 8:00 AM, CluckChicken wrote:

    "What happens if customers' portfolio files are corrupted in an attack? How can they be restored, and how long would it take to restore millions of individual files?"

    That could very well depend on what the action was called. In some of the flash crashes all they reverted all of the trades during a period and accounts were corrected before the markets opened the next day. All of the firms have the ability to run reports to see what trades were made over any period of time.

  • Report this Comment On August 29, 2013, at 1:01 PM, whyaduck1128 wrote:

    I have a few stop-loss orders outstanding, but I use them mostly to insure profits on stocks that have had a good run. "OK, I'm up xx% on this stock, I want to make sure I clear at least xx% if the market makes a major downward move."

    Buying a stock and immediately putting in a stop loss is an indication that you don't have much confidence in it--in which case I have to ask why you bought it in the first place.

  • Report this Comment On August 29, 2013, at 1:17 PM, TMFHousel wrote:

    Thanks for the comments, all.

    Agree with the comments on stop loss orders. If a stop loss triggered after a 20% drop, it did exactly what you wanted and asked it to do.

  • Report this Comment On August 29, 2013, at 10:12 PM, SkepikI wrote:

    <I thought about that, but quickly realized we have three good templates to show the impact on confidence: The 1987 crash, 9/11, and the Flash Crash. I haven't seen evidence that any had a lasting impact on investor morale. >

    Maybe. But if you think about it a bit more deeply, you might conclude as I have that the only one of these events that actually resembles a hacker attack is the flash crash, and I am not even sure about that. The other two, particularly 9/11 were group investor responses to real external events.

    If you are truly an INVESTOR, responses to real events are likely to be viewed as the "ordinary course of business" and more likely to be taken as opportunities in line with your belief in the market (and all its flaws). A successful hacker attack, particularly if repeated somehow, I will be more likely to view as evidence of a new flaw, vulnerability to criminal activity that I did not expect and/or evidence of a "rigged game" (or one that will become a rigged game....)

    Sooo, you may be right and investor confidence will not be more shaken for longer periods than any of the others.... But I for one, would certainly be a lot more cautious and step back for maybe even a year or two till I became much more confident in market security.

  • Report this Comment On August 29, 2013, at 10:15 PM, SkepikI wrote:

    ^ And I can tell you for a fact that in my case, my personal response to the 9/11 drop was the OPPOSITE to what you might have expected.

  • Report this Comment On August 30, 2013, at 3:44 PM, WineHouse wrote:

    Kingfish100's experience exemplifies the distinction between stock traders and stock investors.

    A trader makes (or loses) money by buying and selling shares with a short-term time frame in an attempt to "make a profit" via capital gains. These "stop-loss" orders mentioned by Kingfish100 generally serve only to help guarantee that the trader will "buy high and sell low." It will also help guarantee frequent trading commissions for the brokerage house (even a paltry number of dollars per trade can add up if there are lots of trades). But it won't help guarantee that the trader will make a lot of money over the long haul.

    An investor doesn't try to play games based on market fluctuations, but rather picks companies based on a careful estimation of the likelihood that the companies will do well over time because of their fundamentals, then buys shares of stock in those companies, and then waits.

    A trader is buying and selling shares as if they were commodities on a market (which they are, in the short time frame). An investor is buying a stake in the company itself through the purchase of shares of stock. For an investor, a glitch of any sort that sends a whole index full of stock prices down rapidly in tandem is nothing to worry about. As the author of this article noted, the bakery will keep baking and selling bread. It's only when the fundamentals change (e.g., poor vision on the part of management, as was the case with my biggest investment mistake; I kept buying Eastman Kodak as it went down, down, down, on the erroneous belief that this wonderful company that invented digital imaging and owned all the patents and collected royalties from all the other companies could never go down in flames) that selling in a timely manner becomes important.

  • Report this Comment On September 05, 2013, at 11:02 AM, Peak2Trough wrote:

    Morgan,

    Good article, and I think by and large I agree with your thesis that a one-off market hack would not substantially affect economic output in the country.

    However, if we consider the idea that a series of such attacks over the medium to long term could not only destroy shareholder wealth in specific companies, but could also lead to displaced trust in equities in general, is it unreasonable to assume we would have a scenario analogous to, but opposite from, the Fed's wealth effect strategy?

    In other words, if it stands to reason that the Fed can boost economic activity by holding down long-term rates, driving capital into risky assets and increasing economic activity based on citizens' resulting higher net worth, why would not the opposite also be true?

    P2T

  • Report this Comment On September 14, 2013, at 1:14 AM, snapperreef wrote:

    Thanks for a fine article. We all need to have a lesson in how the market and stock prices vs company value function.

    For one, I would love to have the U S Congress shut down for several longer periods during the course of a year than it now does. If you think about it, and consider the number of laws passed to be equivalent to a stock price, neither tell much about the value of the underlying entity -- the company or the reason for the law.

  • Report this Comment On October 23, 2013, at 8:23 PM, thidmark wrote:

    If you set a stop-loss at 20 percent, you're not guaranteed a 20 percent loss. It could be more. All the stop-loss does is get you out when that threshold is breached. And in a crash, the market price could be much lower.

    In other words, do not use stop-loss orders!

Add your comment.

DocumentId: 2612460, ~/Articles/ArticleHandler.aspx, 7/23/2014 3:49:59 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement