The Stock Market Doesn’t Need Humans
The next time you buy or sell a stock, forget the quaint idea that there is a living, breathing human being on the other side of the transaction. You’re trading with a computer.
Not only are the markets completely computerized, more than half of the market’s volume is churned by computers programmed to spot certain patterns in trading. These machines see stocks not as securities used by companies to raise money, but rather, symbols, numbers and bits that are traded, swapped and exchanged.
Full article on computerized stock trading.
Awhile back I read an article about traders “gunning for stops”. Hedge funds and pensions always have stop loss points, where their computers are programmed to automatically sell if the price falls to a certain level. Traders all know this and sometimes have a good idea where those points are. On lightly traded days (generally afternoons before a holiday weekend), the few traders still on the exchange floor can gang up and force the price down to a certain level triggering the institutional shareholders’ computers to dump stocks, creating an artificial plunge in price. If they can trigger it, a few traders can reap huge rewards. As more computers begin dumping stocks, the price falls like an avalanche. Traders can also make money when the price recovers as investors realize the plunge was artificial.
And yet, there are no hedge funds or banks that substantially outperform the market over the long run. The most successful investor in the United States barely knows how to turn on a computer (if at all). And, most funds are now indexed to the market as opposed to be actively managed.
Virginia, that’s simply wrong. There are many funds that have consistently outperformed the market. In particular, such algorithmic firms as Renaissance Technologies, D E Shaw, and Getco to name three have gotten double digit returns year after year, in up markets and down markets.
You can always find funds that have outperformed the market. The questions are: (1) did they take more risk than the market portfolio and (2) did they outperform by luck or by skill that can be replicated in the future?
I wrote Burton Malkiel to ask about this. Of course he’s all about indexing, but his response was, “Given the entire universe of funds, you should expect to see more that consistently outperform.”
Is it luck or skill?