The Buffett Effect: A Trader's Best Friend?

OMAHA, Neb. ( TheStreet) -- Warren Buffett (check out Buffett's portfolio) is famous for saying that his preferred holding period for a stock is "forever." But much to the chagrin of the Oracle of Omaha, some short-term traders have unusually benefited from Buffett's recent big bet on the railroads.

Notably, the rail industry is not a natural for short-term trading, as the stocks typically trade in a relatively small range. Short-term traders make their big bucks on the likes of volatile stocks like AIG ( AIG), and stocks in more volatile sectors, like technology's Apple ( AAPL).

Still, short-term traders looked to rails after the news of the Berkshire Hathaway ( BRK.A) initial investment in Burlington Northern ( BNI), and subsequent 100% acquisition of Burlington on Nov. 3, specifically because they knew the Buffett name would create unusual momentum in the sector.

"Buffett is the gold standard, and when the news came out on the rails, we started to punch up all of our rail trades," said Mike Bellafiore, partner at SMB Capital. "The Buffett decision becomes a momentum trade, and once the momentum starts to shift, you look to get out quick. It's literally a game of hot potato."

Indeed, UBS Investment Research argues in a controversial report on the rail industry that Buffett has caused successive mini-bubbles in the rail sector. And while the "Buffett Bubble" is open to debate, striking a quick hit on the Berkshire Hathaway's rail-love is a fact that has already booked profits for traders.

Case in point: The rail industry outperformed the S&P 500 for nine days after Buffett's initial 10.9% investment in Burlington, and then proceeded to underperform for a period of eight days. When Buffett took his Burlington stake to 15% in October 2007, the rail sector soared for one day, and then underperformed for seven consecutive days.

To be fair, some institutional investors briefed on the research have voiced skepticism about the Buffett-inspired bubble.

Nevertheless, Rick Paterson, the UBS analyst in charge of the research, said that living through the Buffett investments and staring at the screen every day seeing how stocks traded, showed outperformance over what the fundamentals justified. "It was clearly driven by the Buffett interest, and so where and when he makes a material or dramatic move, yes, momentum jockeys can piggyback," Paterson said.

Paterson noted that investors that bought in mini rail-bubbles #1 (April 2007) and #3 (November 2009) would have made money holding the stock for several days, whereas in mini-bubble #2 (October 2007) the profit opportunity was gone within the same day.

"Some hedge-fund portfolio managers tell their junior guys whenever Berkshire Hathaway's holdings are announced to buy those names all day, and on the railroads they made a ton of money," said a rail analyst who did not want to be quoted on short-term trading opportunities.

Paterson agreed, noting that the rails outperformed 22% in a combined three-week period, just as trade, though admittedly, it was a theoretical trade, and had to be executed perfectly. "Berkshire's regulatory filings are heavily scrutinized for new investments by Buffett, and in the rail sector, we've seen outsized buying on the back of these."

Roger Lowenstein wrote in his 1995 biography of Buffett, that the Oracle of Omaha had "rediscovered the art of pure capitalism -- a cold-blooded sport, but a fair one." Some of the most cold-blooded capitalists seemed to have rediscovered Buffett in the recent rail run-up.

Is there a takeaway message for investors looking to take advantage of the Buffett Effect, and who have the risk profile to stomach it? For one: Initial stakes and outright acquisitions are better short-term plays than re-upping of positions, especially for industries that aren't used to the momentum trends, like the railroad space.

Of course, if you don't want to offend the investment sensibilities of Warren Buffett and believe in the long-term railroad story (and it has a compelling argument) , hold onto the stocks in the sector to which he's just given a huge shot in the arm of confidence.

On the other hand, if you don't want to just be one among the momentum zombies crowding en masse into Buffett's market calls after the fact, and thereby setting yourself up for a potential mini-bubble whack, act fast.

After all, it's always better to be the one heisting the train than to be the one left on the tracks.

-- Reported by Eric Rosenbaum in New York.

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