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The Investor vs. the Machine

By Jack Uldrich - Updated Nov 15, 2016 at 5:06PM

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Individual investors need to practice patience and long-term investing.

Although it received little mention in the popular press, Vladimir Kramnik, the world's reigning chess champion, was defeated last week 4-2 by the computer Deep Fritz, in a best-of-six-game match.

Advantage computer
The defeat was not really that surprising to me. When Kramnik last met Deep Fritz four years ago, he battled the computer to a 4-4 tie. Since then, however, the computer has only gotten better. In fact, since 2002, Kramnik's "Elo" rating -- which measures the strength of a chess player -- has dropped, while Deep Fritz (an improvement from IBM's (NYSE:IBM) famous Deep Blue program) increased the number of positions it could calculate per second from 2.7 million to 8 million.

What this meant in more practical terms is that Fritz could now look ahead a full nine moves. In spite of this advantage, Kramnik figured to be competitive because humans still excel at long-range planning. More specifically, he figured to minimize Fritz's processing advantage by striving for "quiet" positions and exchanging queens early.

Kramnik employed this strategy beautifully in the first game. Alas, he lost his patience in the second game and suffered a humiliating defeat when be blundered into a checkmate, which many analysts immediately ranked as one of the most amateurish moves in the history of competitive chess.

Kramnik, however, quickly regained his composure and battled the computer to three consecutive draws before losing the final game, in which he was forced to take some calculated risks in an effort to eke out a draw for the entire match. (He was down 3 games to 2 at the time). As a result, Kramnik ended up losing not only the competition but a shot at an additional $500,000 in possible prize money. (Don't feel too bad for him, though. He still earned $500,000 for agreeing to the match in the first place.)

I mention all of this because beginning today, Reuters Group (NASDAQ:RTRSY) has begun selling two new services that allow subscribers to set up automatic trading orders based on news. What this means is that computers -- using complex algorithmic programs -- will be executing even more trades now. (Such computers have been used by large institutional investors for some time). This is significant because these computers can conduct trades in mere milliseconds.

Patience is a virtue
Let's assume for a moment that you were able to read about some news that would move a stock -- such as a drug trial failing, as happened recently with Pfizer (NYSE:PFE), or an airline deal between Delta or Northwest and some other airline -- the exact moment that that news hit the wires. Well, these computers are so fast that even if this were the case, you still couldn't beat the machine because from the time it took your brain to process and register that news and then send a signal to your hand to click the mouse on your computer to execute the trade, it would be too late. The computer will have already beaten you to the punch and moved on to other business.

Now, of course, because some people are likely to be slower than you, you can still win sometimes at this short-term game. But my sense is that as algorithmic trading now moves beyond the purview of institutional buyers and hedge funds and begins to be accessed by smaller brokerages, as well as professional investors with the financial wherewithal to buys these programs, the individual investor -- much like Kramnik facing Deep Fritz -- is battling a long-term trend that is not to his or her advantage.

With this in mind, individual investors are encouraged to remember that just as patience and long-term thinking were critical to Kramnik's strategy, that same virtue remains the key to successful investing.

That's one of the reasons I'm so favorably disposed toward Motley Fool Rule Breakers selections Harris & Harris (NASDAQ:TINY) and SunTech Power (NYSE:STP). They're "patient." They take advantage of long-term trends in the fields of nanotechnology and alternative energy, respectively.

As with many new or smaller technology companies, these stocks are going to be volatile, and some investors will profit from short-term fluctuations based on the latest news. For instance, SunTech might land a major contract such as the one I wrote about recently, but this seems to me to be a dangerous game in this new, emerging era of computer-aided trading.

The better opportunity is to strive for "quiet" positions and then maintain those positions. This strategy might not necessarily allow you to beat the computers every time, but it should increase your odds.

Interested in other companies that might represent a computer-beating opportunity? Sign up for a free, 30-day trial to the Motley Fool Rule Breakers newsletter service.

Pfizer is an Inside Value pick.

Fool contributor Jack Uldrich can't even beat his own 5-year-old son in chess. He owns stock in IBM, Harris & Harris, and SunPower Tech. The Fool has an unbeatable disclosure policy.

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