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Algorithmic Investors on Wallstreet
eldavojohn writes "Recently, setting up prediction markets that people play was the big thing to guess the future. But is there a chance that computers will replace investors? From the article: 'Quantitative investment managers use a model to identify sets of characteristics for their investments. Computing power is now relatively cheap. Obviously, computing power can access data almost instantaneously and simultaneously. Asset classes and financial instruments within those asset classes can then be screened and investments are selected. They reflect the manager's views.'"
What they're talking about is arbitrage and trading, not investing. Their trades are designed to be in the short-term. Sometimes, very short-term - within a second.
The key comment was:
More importantly, the models provide insight into market inefficiencies to be applied rapidly across asset classes and the vast number of financial instruments within those asset classes. Whole markets can be analysed daily for buy and sell indications at an individual instrument level. This enables portfolios to contain a larger number of instruments and reduce risk through greater diversification of the portfolio.
As inefficiencies are identified (such as when the return / risk ratio is not correct) provides an opportunity to increase returns by taking advantage of them. Of course, as more people use models the inefficiencies will be corrected quicker, leaving less opportunities to exploit. In effect, the market fixes itself. This, of course, is nothing new - markets adjust to new technologies all the time and eventually the opportunities they offered disappear; for example when the telegraph first came out no doubt someone discovered they could buy an item at one place for less then the same item where they were and arbitrage the prices - but as more people started doing that the spread disappeared.
I'm a consultant - I convert gibberish into cash-flow.
This would true except for the fact that our market is NOT a 'zero-sum' system. Just because someone makes money does not mean someone else has to lose money. Investors are investing in these companies for their own benefit, but what does the company do with this money? They use it to expand their business, fund things, etcetera. This creates wealth -- when a company produces a product, that is wealth, in terms of stock. Nobody lost money in the production of that product. In fact, others probably gained wealth as well, as that company may have bought materials and parts from other companies, with them making a profit off of selling their created wealth. Just because there is a static amount of physical cash in this system does not mean that the amount of wealth is static.
Because they are still growing, the losers are those who grow slower than inflation.
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I have a friend who worked in the hedge fund game for a number of years. He's a brilliant mathematician, and worked on the models they used to inform their trading. The group he worked with was quite successful, and make a heck of a lot of money.
One of his most interesting comments: "The model can inform your decisions, but you have to know when to NOT trust the model." Another of his comments on a completely different talk: "Mathematical models are never perfect, but they can be useful."
The trading system can be modeled, but you can never capture all the true complexity of the real world. If you leave the model to do it's thing, if I know how it's going to act, I can game the system. If the world changes in a way that the model builders did not predict, then the system will also act inappropriately.
I can't imagine ever getting rid of all the traders out there, though I imagine expert systems will become more 'expert' as time goes on.