Stock-Picking Computers

eldavojohn writes "A while ago, Slashdot ran an article on Algorithms used to augment or replace analysts. Today, the NY Times is running an article on stock-picking computers with quotes from the lovable Ray Kurzweil." From the article: "'Investment firms fall over themselves advertising their latest, most esoteric systems,' said Mr. Lo of M.I.T., who was asked by a $20 billion pension fund to design a neural network. He declined after discovering the investors had no real idea how such networks work. 'There are some pretty substantial misconceptions about what these things can and cannot do,' he said. 'As with any black box, if you don't know why it works, you won't realize when it's stopped working. Even a broken watch is right twice a day.'"

Comments

Efficient markets

[Registered Coward v2]

While the idea of stock picking algorithms is neat; market history suggest it won't work a a way to predict performance. What would be interesting is to better search for arbitrage opportunities to exploit faster than others. Of course, eventually others do the same and it becomes an arms race.

Re:Efficient markets

[$RANDOMLUSER]

The only thing an algorithm is guaranteed to do really well is join a panic and dump shares, thereby increasing the panic.

Re:Efficient markets

[SpinyNorman]

It's quite possible that there's so much program trading going on, that you may be able to predict the market (not prfectly, but at least profitably) by effectively predicting what the program traders en-masse are doing. Not that this is necessarily any easier than predicting the mass psychology behind the markets in general, but it does as least point to the fact that much of the market moves according to very deterministic forces.

Anyway, it's already being done, ergo it's possible!

Re:Efficient markets

[mcrbids]

It's quite possible that there's so much program trading going on, that you may be able to predict the market (not prfectly, but at least profitably) by effectively predicting what the program traders en-masse are doing. Not that this is necessarily any easier than predicting the mass psychology behind the markets in general, but it does as least point to the fact that much of the market moves according to very deterministic forces.

And this fact is EXACTLY what stabilizes the market!

As soon as there's a discernable pattern, somebody's going to exploit that pattern in order to make more money, and as soon as that happens, the original pattern gets interrupted, thus stabilizing the marketplace. Perfect? No. But damned good. Some regulation is needed to keep these market forces from being overwhelmed - but the cost of this regulation is a pittance compared to the benefits gained!

Money is an awfully effective invention for distributing wealth, which is why the Star-Trek "utopia" where nobody needs money is not going to happen anytime soon. So long as there is differentiation between different people (and thus resource distribution potential) there will be money.

Re:Efficient markets

[ErroneousBee]

The technical name for this is Technical Analysis, and its a load of bunk.

Sure you can create programs that handle arbitrage opportunities, or detect shortterm effects (market movements lasting less than 1 hour), and these make lots of money for those lucky people who have realtime prices and no brokerage costs (I.e. investment banks, etc).

Stock prices for a company will move on news. Prices may drift around on speculation, but eventually a company will post its trading figures and you will know exactly how much that company is worth at that point in time. Unless these technical analysis programs know which comanies are moving product, who is about to sue who, which companies are in secret negotiations, what the future price of oil will be, etc, then they are going to miss price movements caused by events external to the markets.

Re:Efficient markets

[khallow]

Yes, but it is even more effective at concentrating wealth.

While you probably didn't intend it, that is one of the benefits of money and banking. Back two thousand years ago, almost no one could plan ahead 20 years except the wealthy. Any savings you might have accumulated could easily be stolen. IMHO, that was one of the reasons land was so valuable. Someone couldn't break in and take it and it still had use even if everything on it was destroyed. Now, anyone can concentrate wealth, not just the extremely powerful.

Re:Efficient markets

[khallow]

While this thread has passed all bounds of decency or on-topicness, I do happen to think that money still is far more effective at distributing wealth than concentration. First, money forms a small part of the actual wealth out there which also consists of real estate, labor and education, equities and other securities, savings, etc. Sure one can often trade real estate or stock directly for someething else, but these things aren't in themselves money (unless you're about to claim everything with value is money). Second, money reduces transaction costs. That's it's true value.

I claim money actually reduces concentration of wealth. By reducing transaction costs, it reduces barriers to entry for new businesses and the day to day costs for people with little or no wealth. In the developed world, that is a key factor in reducing wealth disparity. There are many factors by which the wealthy can get concentrate more wealth (eg, corruption of government, rent-seeking), but the presence of money isn't one of them.

Re:It Works

[OneSmartFellow]

That's not the same as automated stock picking.
Automated trading systems 'generally' are used to take a position in a stock that has already been picked.
So, trader A in Goldman Suchs wants to take a long position (buy) 100K shares of IBM, so he assigns that trade to the algorithmic trading engine, which might offer him various algorithms to help fulfill his position at the best possible price, ranging from %vol, VWAP, 'iceberg' or other type of algorithm.

notice, though, that the trader already had the stock to trade chosen, he didn't let the algorithmic engine choose it for him.

Mr. Lo is not smart enough to teach at MIT

[plover]

I hate to be so mean, but anyone who turns down a job from a fund with $20 billion dollars is just not smart. He could have milked that for 20 years! He could be pouring grant money over his breakfast cereal right now, but "oh, no, sorry, but that's not technically feasible." Fool. ANYTHING can be made to sound technically feasible for the right amount of money.

[ Yes, I am joking. I'm quite sure Mr. Lo is brilliant -- just maybe a touch too honest. :-) ]

Re:Mr. Lo is not smart enough to teach at MIT

[cperciva]

[ Yes, I am joking. I'm quite sure Mr. Lo is brilliant -- just maybe a touch too honest. :-) ]

You're assuming that he cares about earning lots of money. More likely, he has enough money, and he wants to do work which he finds interesting -- in other words, he's not turning down the offer because he's honest; he's turning down the offer because he doesn't want to waste 20 years of his life.

Re:Seems only reasonable...

[greg1104]

[Note: the following example is based on my understanding of the stock market, which is most likely wrong]

Completely, but it's good that you know what you don't know--you'd lose a lot less money trading that way. It's impossible to parse stock news and figure out if it's good or bad. Using your example, if Google announces that it will exceed its previously projected earnings, it's just as likely the stock will crash as skyrocket. This is because market participants are working with earning estimation at a higher level than any current generation AI could possibly understand. Read up a bit on whisper numbers to get a feel for the challenges here.

Regardless, the notion that you as an individual could possibly get news and act on it faster than the people that really move the market around is naive anyway. Many of these announcements are made outside of trading hours, and after-hours trading is difficult for an individual to do. By the time the regular market opens up again, the big move is already done.

Humans can't do it...

[Duncan3]

You didn't think the 370 Trillion in derivatives was traded by humans did you?

Of course, the entire planet's GDP is only 60 trillion, so even a little mistake means complete global meltdown.

.