Algorithmic Trading: The Future of Investing

Algorithmic Trading

Summary

  • Artificial Intelligence plays a massive part in our lives and will play a bigger part in our future.
  • Algo-trading has proven to be very accurate and can be a lucrative tool for investors in determining profitable stock picks.
  • I Know First’s algorithm has a success rate that speaks for itself.

Artificial Intelligence

It used to be that if one wanted a computer to carry out an action they would have to program it to do that specific action. This took an excruciating amount of time as we would have to tell the computer to do exactly what we wanted it to do and it was unable to carry out an action which we were not able to do or to tell it to do. Programs had no independent intelligence and could not make decisions by themselves.

Algorithmic Trading

In 1956, computer gaming pioneer, Arthur Samuel, wanted his computer to be able to beat him at chequers. Samuel then programmed his computer to play against itself thousands of times to the extent that the program accumulated sufficient knowledge of the game.By the 1970s, his program was proficient enough to challenge and beat the masters. Arthur Samuel is thus credited with being the pioneer of artificial intelligence (AI).

Machine Learning

Artificial intelligence has now become a colossal industry and is so widely used that it has literally transformed the way we conduct our lives and operate our businesses. All computer games, web-based advertisements, automatic language translators, self-driving cars and even Facebook and Google operate via AI. Just like the Industrial Revolution radically transformed the way mankind operated in the 18th and 19th century, so too AI has radically transformed our way of life in the 20th and 21st century.

There are two different kinds of AI; rule-based and machine learning. Rule-based AI is when an expert would design a set of rules for the program to operate on and the program would be unable to deviate from these set of rules. By contrast, AI based on machine learning is not bound by any set of rules. The program learns for itself and is able to independently make intelligent decisions. These AI programs operate on a specific computer programs called algorithms.

Today, we have more data, faster processors and larger computer memories than ever before. As a result, algorithms are becoming so broad-ranged and clever that incredible programs such as face-recognition, auto-translate and voice-controlled devices have now become the norm. Artificial intelligence has now become, or will become, a vital tool for any business or individual – including investors in stock markets. The computational power available today, in collaboration with the ability to store colossal amounts of data, allows us to do things that were simply not possible before.

Picking Stocks to Invest In

How should one pick stock to invest in? Some courageously look for companies with an eye-catching story in the news or those rumoured to be subject to a takeover and invest or divest accordingly. If the news happens to be positive, then the stock will be on the rise, they will thus buy the stock in the hope that it will appreciate further. Some of those investors are lucky, but most tend to overpay and lose money.

Others purchase stocks in companies that produce products which they like. A lot Apple (AAPL) investors and sports fans belong to this category. They could potentially make gains, but if not, they will be a proud of owner of a company which they like – a win-win scenario.

Accounting minded people like to purchase stocks through a method called value investing. This method is based on the hard facts and statistics illustrated on the balance sheets. One would peruse through the balance sheets and attempt to evaluate how much the company is worth – a technique favoured by Warren Buffet.

Algorithmic Trading

Fundamental analysis methods, such as those analysed above, is immensely important in deciding to invest in stock. However, the current stock price more often than not reflects the known fundamentals. As a consequence, buying a stock in favour of another will have no advantage whatsoever. Also, if the fundamentals do not change daily, how come the price does? Hence, those who rely exclusively on fundamentals are disregarding lots of information that is encoded and intertwined with the daily price movements.

Then we have technical analysts – chart readers. They examine chart patterns in an attempt to find oversold or overbought stock. A technical analysts would then utilise past patterns to predict future patterns and invest accordingly. The key flaw with this method is that, as the world constantly changes at such a fast speed, past patterns are unlikely to repeat themselves. Seemingly, the indicators of the patterns would also lose its effectiveness if large quantities of trades are made on that particular stock.

Algorithmic Method

Every stock is affected by millions of critical factors and market waves which ultimately affect its trading price. The I Know First algorithm simply take all tradable assets (stocks, currencies, commodities, indexes etc.) and combine the decision making components with technical analysis using computers and math in order to create a final signal which will predict the direction the asset will move.

Put more simply, the algorithm is able to analyse lots of dynamics, often unknown to analysts, which could affect the future market price and thus forecast the future price movement in advance. Correspondingly, the algorithm generates relationships between vast varieties of financial assets and is capable of altering, eliminating and creating new relationships.

 

Basic Principle

 

(Source: I Know First)

The algorithmic forecast is based on these relationships, their surrounding parameters and current market data. Since the algorithm learns from previous forecasts and is continuously adapting the relationships, it is capable of quickly adjusting to a fluctuating market.

As a result of the algorithm learning from past data and previous forecasts it consequently becomes more intelligent and produces increasingly more accurate forecasts as time progresses. By the same logic, long term forecasts are hence more accurate as the algorithm has had more data to evaluate.

Advantages

There are two key human emotions behind all bad investing decisions; greed and fear. Greed encourages an investor to make completely irrational decisions in pursuit of gaining a few extra dollars and fear would scare investors away from making a fantastic investment out of fear that they would make a loss. Therefore, the use of algorithms in choosing a stock pick eliminates the problems of irrationality and impulsiveness.

An algorithm is far cleverer than a human stock picker and is able to scour over mass data, finding patterns and determining the direction of stocks, bonds, futures, currencies and options in a matter of seconds which gives algorithmic analysis more knowledge than any amount of human resources.

Disadvantage

The algorithm is merely a computer program and therefore cannot factor in current affairs, natural disasters and short-term radical macroeconomic changes. Investors using the algorithmic approach are therefore advised to use their knowledge of current affairs in combination with the algorithmic analysis in order to pick stocks.

The algorithm is not 100% accurate, but its accuracy is enough to make a difference – enough to make a profit.

How Successful is the Algorithm?

I Know First’s experienced algorithm make algo-trading less prone to losses. But perhaps the best argument in favour of algo-trading with I Know First is the algorithms brilliant success rate. The algorithm has data stored from over twenty five years ago and has over five years of self-learning under its belt.

One of the more profitable algo-trading strategies used by our clients is Dr Roitman’s five-day swing trading strategy.

A model of this strategy was constructed with a $10,000 fund and the overall return in the one year period from July 1st, 2014 to June 30th, 2015 yielded and overall return of 83% while the S&P500 average rose by 5.2% during the same period.

Algorithmic Trading

(Source: I Know First R&D)

However ridiculously improbable that may sound, the algorithm’s average return for the forecasted top ten stock picks consistently beats the S&P 500 average return. Therefore, a patient experienced investor with a proven algo-trading strategy, can realistically make highly lucrative returns which makes the returns in the above simulated swing-trading strategy much more plausible.

Conclusion

The fact is that algorithms are simply much cleverer, faster, and can condense more information than any human can possible dream of and, therefore, whether we like it or not, trading via artificial intelligence is inevitably the trading method of the future. Algorithms by nature become cleverer and more efficient as time progresses which makes I Know First’s experienced algorithm amongst the most advanced in the algo-trading world.

Regardless of whether an investor would solely base their investing decisions on an algorithm or whether one would merely use the algorithmic analysis as guidelines, with such accurate forecasts, it will be an erroneous decision to completely disregard algo-traders as a cluster of tech-savvy marketers looking to make a few easy bucks.