I know what is going to be on the minds and lips of just about everyone for the next couple of days.  “Did you see that stock market?!”  Everyone, of course, will be talking about the nearly 1,000 point plunge in the Dow Jones Industrial Average around mid-afternoon on Thursday.  This is the largest single point decline ever in the history of the average, even though the market managed to recover and only close down a little over 347 points.  So just what the heck happened and how worried should we be?

From based on all the scuttlebutt running around the market, it appears that someone pulled a major goof today.  Further, as if to add insult to injury, there is talk that the huge error occurred at, of all places, Citigroup.  The assumption at the moment is that some trader accidentally entered “billion” when he meant “million”.  Oopsy!  So what did this huge error mean?  Well, let’s look at what we saw during the day versus reality, first.  Then we’ll dive a little deeper into the long term implications for today on our holdings.

So what exactly went wrong?  Well, let me try to explain, given the limited information that has come out so far on the trading day.  It seems that some trader did apparently enter an order incorrectly for some futures on the S&P 500 stock index.  It seems that it was a “b” that was entered instead of “m”.  This means that somebody was mistakenly trying to sell billions of dollars of stock when they only meant to sell millions.  Now, selling millions of dollars worth of stock may sound like a lot to mere mortals such as you and I, but the truth is, that’s not a lot given the size of our stock market and the number of shares that trade every minute of many securities.  Heck, Apple Inc. stock trades about $12 million worth of shares every minute.

So, this errant trade for billions is accidentally entered into the system.  The folks on the floor of the New York Stock Exchange, who are responsible for making sure that orders flow smoothly, see this sudden request to sell untold thousands of shares of the stocks in the S&P 500 Index.  Well, these specialists (as they are known), are sort of stock retailers.  They first try to match up buyers and sellers.  However, if there is no one willing to take the opposite side of trade, they must be willing to take the trade.

Now, think about it from an eBay perspective.  You are selling rare wine on eBay.  You have listed a bottle of a fine Rothschild vineyard wine that you believe is rare with only a few hundred bottles known to be in existence.  You can command a pretty fair price for this wine.  Others see you earning some nice profits on this wine, so a couple of other folks list their bottles.  Well, with more choices now, prices would drop a little bit.  Suddenly, someone errantly types in ‘Rothschild’ when they meant to type in ‘Boone’s Farm’ and suddenly it appears as if thousands of bottles are for sale.  Prices plunge.

This is essentially what happened.  This errant trade came across to these specialists who realized that it had to be an error.  Even if it wasn’t an error, these guys needed a little bit of time in order to find enough volume to meet that demand.  So, they slowed the market down – literally.  The specialists put in place a “time delay” between when orders came in and when they were executed.  The put a thirty second delay in place.  However, some brokerage firm computers were impatient.  Rather than wait the thirty seconds, the computer searched elsewhere for the same security to sell.  The computer stumbled across some old order on another computer that had been entered months ago to buy, for example Proctor & Gamble for $40 per share.   The would-be buyer may have entered that order in March of last year hoping against hope that P&G would come back to them.  It didn’t and now the stock was trading around $60 per share – until yesterday.  When these brokerage firm computers went searching for anyone buying P&G stock, they found that one order for 1,300 and a sale was done.  This was sort of a “rogue” trade, though.  The real price for P&G on the NYSE was never below $58 per share.  Trades like this were happening throughout the market.

What made yesterday frustrating was that most stocks that were affected by the severe drop never should have dropped.  For example, I sat and watched as Buckeye Partners (BPL) stock, which we own for a number of client accounts, fell from $58 at the start of the day to as low as $45 at one point before rebounding to close at $54.  Buckeye is a company that acts as a giant taxi for gasoline and other refined products.  It moves gasoline, jet fuel and other end products from refineries to storage facilities and stores these distillates until shipped to the end users such as gas stations.  Buckeye Partners is paid not on the price of oil but on how much is shipped and how far.  At the current price, Buckeye shares are yielding 6.94% based on their recent quarterly dividend – which has increased every quarter since the second quarter of 2004.

Another stock that we own in some client accounts that was momentarily hit hard is Exelon Corp. (EXC).  Exelon is a utility.  In fact, it’s the largest generator of nuclear power in the nation with eleven plants.  During the time of this mysterious plunge, Exelon theoretically sold for zero!  Yes, you read that right.  Zero.  It’s one of several stocks that supposedly were sold for absolutely nothing.  In all likelihood, that particular trade will be ‘busted’.  That is, the trade will not be honored by the stock exchange as a valid trade, so the seller will get his or her shares back and the buyer loses out on owning EXC at a cost of, well, nothing.

All of this insanity essentially took place during a very short twenty minute window from around 2:30 pm until 2:50 pm today.  Making it more difficult to profit from this bizarre incident, it was impossible to find the stock to purchase.  For example, going back to Proctor & Gamble, the lowest price occurred on the sale of only 1,300 shares.  Consider that on a normal day, about 28,000 shares of PG trade every minute of the trading day and you see how small a single trade of 1,300 shares really is.  To put the dramatic move in our Buckeye Partners stock into perspective, on a typical day the stock trades within a narrow range of a little over $1 per share.  Today’s range was over $13 per share.

So how are we affected by all that is going on?  Well, obviously, we’re not really affected by errant trades.  If we don’t panic and sell into insanity, we’re fine.  As for the Greek problems that were already causing weakness in our stock markets yesterday, even before the rogue trade, we are somewhat protected against that, too.  Many of the stocks that we own are U.S. companies with a focus on the U.S. economy.  Sure sales could decline somewhat if the economy does slow down, but we are largely protected from heavy exposure to Europe at the moment.  With companies such as Buckeye Partners or Frisch’s Restaurants (FRS), a company that runs Big Boy and Golden Corral restaurants in Ohio and Indiana, or Nash Finch (NAFC), a company that supplies grocers and commissaries on military bases with groceries, we are betting, like Buffett, on the recovery and growth of America.

How will we be handling this volatility and opportunity?  Well, let me start by telling you how I handle our accounts.  I have a Sunday evening ritual whereby I will go through each and every stock we own and look at it on a point-and-figure chart (one just like you see in the article “Pointing the Way Out of Confusion” below).  What I am looking for in these charts is a trend, direction and a “stopping” point or the trigger point that I would cause me to either seriously re-evaluate our stock holding (i.e. question the reason and thesis behind the purchase) or sell it outright.

As stocks were tanking today, we did take a little money off the table based on the research we did this past Sunday night.  While a part of me regrets acting in haste, the one stock that we sold, an exchange traded fund of high-yield bonds (HYF), did reduce risk for our clients.  There are a few names in client accounts, names such as ConocoPhillips (COP) that we own and the charts tell us ‘sell’.  However, the charts can’t look at the intrinsic value of the company and tell us the stock is undervalued.  By our calculations, the stock is worth about $105 per share.  Conoco is working to unlock shareholder value by selling off underperforming assets, raising cash to reinvest in higher margin investments, reduce debt and likely returning some cash to shareholders through dividend increases and stock buybacks.  Oh yeah, and the stock is currently yielding 4% based on the current price.  I think I’ll trust my investment thesis over the charts on this one.

There are a few stocks that we are likely to try to pick up if this slide continues.  We are likely to use options, just as we did in late-2008 and early-2009, to take advantage of this increased volatility.  We’ll probably sell some puts, obligating us to purchase shares of companies, but only on stocks we want to own anyway.  While the recent declines have given us pause, we are nowhere near levels of a year and a half ago.  In fact, we are still 67% above the March 2009 lows.  In other words, stocks have become a bit cheaper, quality stocks are moving back towards bargain territory and volatility opens up some opportunities for us, but we’re not getting greedy and we’re not at a “screaming buy” just yet.  We’ll continue to look at ways to hedge our client accounts, take money off the table when it’s appropriate, reduce risk across accounts and play a good offense by playing better defense.