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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.'"
Discssing this on /. is futile...
Anyone who really knows anything about this subject wil not post. Too much going on in trading land...
Hence AC post...
If you have a giant set of data, and you set a computer on it for long enough, it should be able to come up with some rather solid paterns/corelations/etc. You come up with these things, and if you don't have to wory about paying the stock broker what ever cut for each transaction (because you are the broker), then constantly trading on these thigns seems like agreat idea.
However, it still can't predict things that a human can (yet). I doubt that a computer can incorporate thigns like global news, company announcements, and other such real world variables into how it makes judgments. That was the one thing that the article didn't really talk about.
So I doubt we will see these "black boxes" replacing brokers, simply suplimenting them.
Do Or Do Not, There Is No Spoon, There Is Only Zuul. Everything in the above post is probably opinion.
There are so many theoretical problems with automated stock picking systems that I could spend all day working on this post. Instead, I'll ignore all but two.
First, no matter how well you can predict based on patterns, when you are picking individual stocks, there is such a huge influence from the chaos of human nature that, from day to day, no matter how appropriate your predictions are (based on history), they may have nothing at all to do with reality.
Additionally, if you get enough of these stock picking systems in operation, they can actually change the dynamics of the market, keeping them from being accurate for years as they all try to account for the activities associated with each others' predictions.
The problem with stocks is that in order to know how they are going to perform, you have to know not only what the company is going to do and how their customers are going to respond, but also how the investing public is going to take that news. It's an odd mix of fundementals and faith, in my experience.
The CB App. What's your 20?
In some cases, the result seems to work more consistently.
I had a friend who worked in the AI department of Lockheed (about 20 years ago) and they developed the software that was used for the Robert Prector's Elliot Wave newsletter. Every two years they would give the program to a couple of people to try for 6 months. These people would invest $10,000, use the program and follow the guidelines, then evaluate the results. I was privy to the outcomes of three of these tests in the mid-nineties, and the lowest was earned $15,000 and the highest was earned $36,000. These are pretty good results. (However, the stock market was steadily climbing during those years and I wasn't able to compare results with EWT competition. Still, if I was able to consistently get 30%/year on my investments...)
Back in the 70's, Dean Witter had a program called PACE. I know two people who had a system for using it that earned them over $100,000/year, and they never deviated from the program while I knew them.
Then I have a friend who is a very conservative money manager (manages a couple hundred million of other people's money), and over the period that stocks crashed (remember Enron and Worldcomm?) he only had two clients lose any money, and the biggest loss was less than %15. He claims that these programs are mostly bunk. (This guy is a perfectionist, and I bet a computer is no more disciplined than he is.)
These programs are not investment management programs. The principles of investment management are pretty simple. The best book I know on the subject is still Benjamin Graham and David Dodd's book, "Security Analysis". However, the problem is finding opportunities that comply with the principles. Systematic data analysis by computer could have a profound effect, and that's what most of these programs do.
BTW, the article mentions that profits are slowing down: In Robert Prector's book, "The Elliott Wave Theory" and in his newsletter, he sort of predicts that as information becomes more available for analysis trading will be done more rapidly on spreads that may show profits as low as 1.5%
"The mind works quicker than you think!"
The last work of Mandelbort (the 'fractals' father) 'The (Mis)behaviour of markets' http://www.amazon.com/Misbehavior-Markets-Benoit-M andelbrot/dp/0465043550/ is quite interesting.
Sigh, markets are chaotic, much more chaotic than current market analisis states.
What's in a sig?
As another poster has already mentioned...read the story of LTCM. The notable quotes from the article are
In theory, making money in stock market should be easy. Buy low, sell high is a guaranteed successful investment strategy and yet few people follow it. Why is that? By definition, an undervalued stock is an unpopular stock. Doing the unpopular thing is very difficult. Quite simply, human beings are a social animals and going against the crowd is often not in our best interest. Investing in unpopular stocks almost always feels wrong.
However, if you take a rational look at popular and unpopular stocks, you will see that the unpopular stocks are the ones likely to be the real money makers. Consider a mythical corporation that we'll call XYZ Corp. Let's assume that there is a lot of popular interest in the stock. The analysts all believe that great things are in this company's future. Should you invest in it? No, because the stock's price already reflects belief in the company's rosy future. The price of the stock always reflects everything that is known about the company. This concept is important to grasp.
Now, let's consider the future. The future is, of course, impossible to predict, but two outcomes are guaranteed. Either the company will live up to the investors' expecations or it will not. If it does live up to the company's expecation, the price of the stock may stay flat or rise only moderately since the stock price already reflects the high expectations of the investors. If the company fails to meet investor expectations, the price of the stock will drop in response to lowered expectation. Popular stocks don't have very much upside potential in the long run.
Now, let's assume the converse. XYZ Corporation has been mismanaged and had some bad luck. Investors and analysts now consider this stock a "dog." What are the possible outcomes for this stock? Currently the stock price is depressed because it reflects all the pessimism folks have about the company. In the future, either XYZ Corp will continue to run the company poorly or it will change its business strategies and turn itself around. The price of stock will stay flat in the first case and rise in the second case. Unpopular stocks have a great deal of upside potential and little downside since the price already reflects low expectations.
Care to post a link? Thanks.sure.y Id=6203264
http://www.npr.org/templates/story/story.php?stor
My own portfolio is a bit simpler. UK index linked mutual fund, developing country mutual fund, government bonds, commodities (gold silver), housing stocks. Basically about 20% in each sector. Try to spread your portfolio over several sectors which don't all go in the same direction at the same time.
The strategy is simple but it's the important bit because it stops you buying at the top of the market. It's called rebalancing.
Every month add the £100 (or however much you want to invest) to one of the categories. You choose the category by taking an average of how much you've invested so far, divided over the categories. Say after a year you've invested £1200,the average which in my case should be in every category is about £240. But the market goes up and down so some sectors will be doing badly, they'll be below the average, some will be above the average. Well, the whole idea is to buy low, sell high, yeah? You invest your next £100 into the sector in your portfolio which is the furthest below the average, so topping it up. This way you're always buying into a sector when it's low, not high.
Sit down once a month with a spreadsheet (or calculator, it really isn't that hard) and work out where to put the money this month. You spread the risk over 5 or however many categories/stocks you want to take, when the markets change direction, as they inevitably do, your cheaply bought investments will go up most and you are not putting your money into expensive top of a peak stocks.
It's simple and it works, as mentioned in the link the pros do it on a minute by minute basis rather than on a month by month basis (and they sell as well as buy) but I'm really not that interested in finance, and I don't need to be interested or knowledgeable. I'm beating 10% per year for an hour a month.
Oh and always stick the monthly £100 into a single category, don't try to spread it because fees etc will be minimised.
Deleted
A HUGE amount of the market is in retirement funds or investment funds designed to be liquidated through retirement. My generation will be retiring soon, and withdrawing their funds from the market. If the USA keeps producing, it may be a good place for foreign investment that will buy the stocks being sold. However, there's about 10 Trillion dollars of off-balance-sheet liabilities in Social Security, Medicaid and Medicare out there. (If the USA was Enron or Worldcomm, the last 8 Presidents and all the legislators would be in prison today.) I suspect that the government will fund these liabilities by inflating the currency and raising taxes, making the USA attractive investment opportunity for only China. The gambling schemes, including the derivatives you talk about, will fold. The world will get hungry...invest in food.
I support the investor's right to be as stupid as they wish. A buy and hold regulation won't do as much good as something like the Fair Tax Plan, increased personal debt reduction, a balanced budget, and reduced spending. Presumably, investments are property that an investor should be able to divest anytime. Leave the government out of it.
"The mind works quicker than you think!"
First of all, the article summary seems a bit misleading because people might think we're talking about "stock picking" as in analyst opinions/monkeys picking stocks. That's not so, this is about software driven trading. Often this is of a very short term nature, so in a way the growing use of program trading is the "new day trading" fad.
In the industry it's called "program trading" and refers to automated, algorithmic trading of instruments such as stocks, futures, forex. This is regularly done by many banks and large funds, and also small investors. In fact there is a discount brokerage which I'll just call IB here, that has an API which lets anyone program their own computerized trading. It's a bit "too easy" to do.
That doesn't mean it's always profitable in the long term, but without a doubt people are profiting at least in the short term. The software has multiple strategies, well documented approaches and algorithms. Generally the trading robot is trying to ride trends.
As someone who follows these things, here are a few criticisms I'm aware of:
1. These short term trading activities require high leverage, because trades have to be for large amounts of money to make them worthwhile. You need large amounts of money to make this work, because things like trading costs eat into profits tremendously. Again, like day trading.
2. High leverage is risky because one big mistake or unpleasant event could wipe out tons of past small gains. Risk management becomes a key issue. Some would argue that perceived risk in markets these days is unreasonably low. Does this unbalance the risk/reward equation?
3. Market-wide, we know program trading has increased dramatically on US exchanges. Add to this the undocumented program trading (smaller traders who don't have to report it to anyone) and basically there are a ton of computer algorithms out there today trading stocks. Everybody can't make money at the same time, so to profit the participants have to use even greater leverage = more risk.
4. Programming flaws, bugs, or improper risk management could have tremendous market-wide implications. Take for example the huge market moves in 1987; the drop was a "20-sigma" event and not anywhere within the realm of possibility back then. Obviously the models failed to handle it. Similarly, the next time we have a "big event" in markets, today's algorithms might fail. If a large number of computers choke while trading, could bad things happen?
5. So under unstable market conditions, the program trading could lead to increased volatility (like daytrading caused volatile markets during the crash). But under stable market conditions, like we have today, program trading seems to smooth out daily movements. Notice that the US markets hardly move as much as 1% in a day; trends are smooth and volatility is extremely low. The VIX, a volatility measure, has hit historic lows.
The communist ideal of Star Trek, as I see it, is possible only because of the replicator.
Consider what happens when it is possible, given an example of a given product, to duplicate it en mass at near-zero cost. Suddenly nearly everything's free. Manufacturing costs nothing, so it's all in the pattern that tells the replicator what to build. This makes it difficult for the capitalists to retain control. They can attempt to retain monopolies on their own replicator patterns, but once the workers, owning their own replicators, begin designing their own replicator patterns, and sharing them amongst themselves and building on each other's work, then the capitalists could end up totally sidelined, made irrelevant by a proliferation of free replicator patterns, put to use to create free products. Would the workers' collective creations be as good as the capitalists' refined and expensive designs? Probably not in every case, but they'd be good enough, and it's hard as all hell to compete with free.
This is happening in one segment of the market right now, and the capitalists there are getting desperate: look at Trusted Computing and the idea of Software Patents, as the bosses try desperately to wrest back control of the means of production. Sadly it can't go all the way; the workers distributing their free software still need to eat! But if we could duplicate material goods as easily as we duplicate software, we could GPL the entire economy and let the workers' socialist revolution really get going.
Real Daleks don't climb stairs - they level the building.