Stock-Picking Computers 218
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.'"
It Works (Score:2, Informative)
Re:Seems only reasonable... (Score:3, Informative)
Actually I was surprised how few references I could find to this sort of thing. Still I don't believe this is an indication that it's not happening; rather, I think market prediction is a black art because investors don't want anybody else to know what they're doing or how they're doing it.
The problem is markets are choice based (Score:3, Informative)
You wanna use your computer? (Score:2, Informative)
Or you could try genetic algorithms, download the info on the whole market plus historical info, give the algorithms access to the lot, plus downloaded financial news, classify the financial news as good or bad for a stock using a bayesian classifier, add that to the pot and then use evolution to see which algorithms survive best in the market to date.
You may need to build a supercomputer to run enough algorithms to perform the search. Look at it this way though... NOW you have an excuse.
Re:It's harder than it looks (Score:4, Informative)
Re:This would be my request... (Score:3, Informative)
However, while it's fun to play around with a system like this, I must warn you that the realities of trading make it very hard to profit even if it looks good on paper. You probably know this, since you "got burned" before. Make sure you consult a professional before investing, or I can pretty much guarantee that you'll get burned again.
Re:Efficient markets (Score:3, Informative)
Um, that IS beating the market: all investments are a combination of risk and expected reward (e.g. treasuries are low-risk and low-return, junk bonds are higher risk and higher return.) If you can reduce risk without reducing return, you can make buckets of money (people will line up outside your door wanting to give you capital.)
That said, don't trust any academic studies on this topic. There are probably only 50 people on the planet who actually deeply understand this topic, and they aren't talking. E.g. when I was running a hedge fund in the early 90s, most of the techniques described in the article were already widespread (yes, we had real-time newswire scrubbers running back then.)
As the article touches on, speed is important: a 5 millisecond advantage lets you make real money without needing to predict anything. The predictors do make excess profits, but most either don't understand the risks they are taking, or actively hide those risk from their investors. D.E.Shaw, mentioned in the article, basically blew itself up back in 1999 or so. LTCM did the same thing.
Re:Why? (Score:3, Informative)
In fact, in the Wall St. Journal's long-running contest, the experts have out-performed the darts 29 to 21 times (ahref=http://www.webtrading.com/issue18.htmrel=u
However, in the less-long-running contest of Wall St. Journal readers versus darts, the readers are getting trounced 13 to 9 (ahref=http://online.wsj.com/article/SB1158452140
What is true, and more damning to investment professionals, is our poor performance versus broad-based indexes, which are inexpensive investments.
Re:Efficient markets (Score:3, Informative)
If the Efficient Market Hypothesis were true, stock pickers like Cramer should have been driven out of the market by now. Some investors do, on average, beat the market. See Warren Buffet. Now. The hard part is figuring out if your analyst is the next WB, or just some MBA who isn't too stupid and had good luck on top of not being too stupid... for the last 5 years until he regresses to the mean for the next 10 years. So. If you could write software that picked *analysts* then maybe you'd have something. Trouble is, they're humans. They get divorced, get sick, die, decide they've made enough and want to drop out and do Yoga, etc. Anyway. Bottom line? Not everybody agrees that the market is efficient. I know I don't. No way. Not by a long shot. It's like poker. You'd think that skill is only a small part of the game, and that it's mostly chance. For many players, it is... or at least that's what I thought until I saw a truly skilled player take out an entire table. It was amazing to watch this guy know exactly how to play every hand. Amazing. Never saw it before. Might not see it again, since I'm not a big poker guy. I suspect investing is a lot like that--there are a handful of guys that belong in the investing equivalent of the big poker tourneys. Everybody else is a loser.
Re:Economy question (Score:3, Informative)
Investment markets like the NYSE and the Chicago board of trade arise from the desire to mitigate risk on investments. Rather than buying a lot of one company's bonds or stocks, buy several. You increase the potential that some of your bonds may fail, but hopefully decrease the chances that they all fail. There's tons more ideas like this out there, but I hope you get the idea. Trading involves two investors adjusting their holdings to match their risk preferences. Some people, especially young people, may prefer riskier investments, because they have a long time left to save for and can outwait a 10 year slump in the market. There does exist a class of traders that buy and sell stock looking to make a profit off of other investors, but generally profits come from the creation of wealth, ie firms paying people to make something and selling it to the public.