Pablo Picasso once said:
“Computers are useless. They can only give you answers.”
I saw that today for the first time. Made me pause because I agree 100%! Let’s face it, it used to be more about having the right strategy and then hopefully making money. Today? Trading and investing has become a technological “math-turbation” marathon of red lights, green lights and six monitors on your desk:
“Do you have the latest software?” Do I need this indicator?” “How are your candlesticks plotted?”
Before digging in…let me say that this subject is nuanced.
Larry Hite, a prominent trend follower, once said that a computer can’t get up on the wrong side of the bed in the morning, which is why he relied on computers for decision-making:
“If your boyfriend or girlfriend breaks up with you, you’ll feel one way; if you get engaged, you’ll feel another way.”
But it’s more than just that.
Hite went on to say he would much rather have one real smart guy working on a lone Macintosh than a team of well-paid timekeepers with an army of supercomputers. At the same time, however, Hite was adamant that the real key to using computers successfully was the thinking that went into the computer code. When someone asked why even go the computer route if people power was so important. Hite responded:
“[B]ecause it works, it’s countable and replicable. I’m a great fan of the scientific method. And the other things are not scientific. If I give you the algorithms, you should be able to get the same results I did. That to me means a great deal.”
However, there are challenges that go along with PC-based trading. Computer technology can be easily used to over optimize or curve-fit a trading system and produce a system that looks good — on paper. By testing thousands of possibilities, anyone can create a system that works in theory as [Donchian student] Barbara Dixon warned:
“When designing a system, I believe it’s important to construct a set of rules which fit more like a mitten than like a glove. On the one hand, markets move in trends, but on the other hand, past results are not necessarily indicative of future performance. If you design a set of rules which fit the curve of your test data too perfectly, you run an enormous risk that it will fizzle under different future conditions.”
However, you are in serious trouble if all you think you need is the latest hardware and software to succeed at trading. Dixon adds:
“Contemporary databases, software, and hardware allow system developers to test thousands of ideas almost instantaneously. I caution these people about the perils of curve fitting. I urge them to remember that one of their primary goals is to achieve discipline which will enable them to earn profits. With so many great tools it’s easy to change or modify a system and to develop indicators rather than rules, but is it always wise.”
It is difficult not to get caught up in the hype of computer programs for trading. You can go out and spend several thousand dollars to purchase fancy charting software that makes you feel like you are the president and sole trader of your own hedge fund. What were trend followers doing before they had PCs? When describing his early trading successes John W. Henry made clear the key was philosophy, not technology:
“In those days, there were no personal computers beyond the Apple. There were few, if any, flexible software packages available. These machines, far from being the ubiquitous tool seen everywhere in the world of finance and the world at large today, were the province of computer nerds…I set out to design a system for trading…”
One of Henry’s employees years earlier elaborated:
“Originally all of our testing was done mechanically with pencil and graph that turned into lotus spreadsheets, which was still used extensively in a lot of our day to day work. With the advent of some of these new modeling systems like system writer, day trader and some of the other things, we’ve been able to model some of our systems on these products. Mostly just to back test what we already knew, that trend following works.”
Trader Tom Basso’s experience was also noteworthy:
“You’ll find that the more you’re computerized, the more markets you’ll be able to handle. Computers leverage your time if you know how to use them.
Trend following grandfather Richard Donchian’s timeless observations should likewise cause new traders to pause:
“If you trade on a definite trend following loss limiting-method, you can [trade] without taking a great deal of time from your regular business day. Since action is taken only when certain evidence is registered, you can spend a minute or two per [market] in the evening checking up on whether action-taking evidence is apparent, and then in one telephone call in the morning place or change any orders in accord with what is indicated. [Furthermore] a definite method, which at all times includes precise criteria for closing out one’s losing trades promptly, avoids…emotionally unnerving indecision.”
Of course to reach the ‘minute or two’ Donchian refers to takes preparation time. I am not minimizing the work and effort needed to succeed, but I am quoting him as great insight and motivation.
At the end of the day the rationales on this page are why clients have trusted my firm for over a decade to help with their educational needs.
One last thing. I mentioned “six monitors on your desk.” Why is it that the great trend followers have never done that, but so many new traders think it is important? Food for thought.
Bottom line: this should NOT be what you are doing all day!
Note: Some content from this post is from my book “Trend Following.” And shout to Ritholtz for desk image.
