The Focused Investor 1: Alexander from Day Trading Z Robots vs. Human Traders

This is the first post in Minafi’s The Focused Investor series. This series is a chance to hear investing opinions and takes that may differ from my own, but are core to someone else’s investment strategy.
Adam

Written by Adam on January 10, 2019. Updated April 25, 2019.
8 min read. Investing. 2 comments.

Minafi's finances are an open book. Find out how I make money.

This is the first post in Minafi’s The Focused Investor series. This series is a chance to hear investing opinions and takes that may differ from my own, but are core to someone else’s investment strategy.

Each Focused Investor article touches on 3 parts:

  • Who’s writing and why are they writing about investing?
  • What is one core investing opinion you believe in?
  • What advice do you have for someone getting started?

The goal of this series is to see what different investors feel is the most important core opinion about investing and share how they believe someone could get started today.

DAYTRADINGz com Logo

This week features Alexander from Day Trading Z who has been writing about investing since 2016 on his blog. One of his focuses is on day trading – an area that is quite a lot different from my minimal investor style. Check out DayTradingz.com for more articles, or follow @daytradingz on Twitter. Here’s Alexanders great take on a subject that i’ve been increasingly fascinated about:

Robots vs. Human Traders. Who Is Performing Better At The Moment?

Alex

Automation is slowly but steadily penetrating each and every aspect of the economy. This is the case with the trading industry as well. Currently, it is just 10% of all stock picking that is performed manually. The rest is fully automated. The reason is that robo-traders are drastically transforming the financial landscape and are providing a cost-efficient alternative to their human colleagues.

Investors are buying and selling stocks by using online trading software, trading platforms or even investing apps. The times where investors reach out their bank advisor by phone are gone. One mouse click and stock changes his owner within a fraction of a second. But it gets even further. Robots trade automatically based on complex mathematical algorithms and invest the money completely independent from individual human decisions.

My name is Alexander, I founded my blog back in the year 2016 and enjoy writing about investing, trading and the latest financial technology evolutions. Today I will guide you through the world of automated trading. Continue reading to find out who is performing better at the moment – Robots or Humans?  

What is A Core Opinion Investing Opinion or Strategy For You?

I believe that focusing on low overall costs is the key to long-term success. No matter if you invest or trade, no matter if your approach is conservative or speculative. The total costs are the most important aspect along with the security of your funds.

Robo- vs. Human Traders

Big companies are starting to think about making the transition from human to robo-trading. This will result in a gradual reduction in the number of human employees at their trading desks.

The reasons for that are mostly related to minimizing costs and optimizing the trading process. Of course, humans remain in charge of the strategic decision-making process, but the more daunting and time-consuming tasks are mostly automated.

Yet, there is no right answer to the question which type of trader is the better one overall. Both, the digital and the human trader have their respective pros and cons which make them suitable for different types of jobs and trading methodologies.

Pros and cons of robot traders

Pros Cons
Cost-efficient Lack intuition
Quicker and easier Lack intuition
Prone to emotions and human biases
Consistent and more productive

Pros and cons of human traders

Pros Cons
Can contextualize information More expensive
The better and more experienced type of trader for the short-term (until the technology develops further) Limited amount of work that can be handled
Easier to spot market inefficiencies Can be biased
Resistant to technological glitches

Most of the time, human and robot traders are complementing each other. For example – the automation of the portfolio backtesting process saves tons of time and is capable of providing more accurate estimations. The human portfolio manager is then presented with data-backed conclusions and error-free suggestions, which can be applied directly. This significantly optimizes the efficiency of the process.

But in reality, the trading field is not so balanced. There are AI-based funds, run entirely by robots that are handling the whole process, from the backtesting, through the stock picking and asset allocation, to the investing part, all on their own, without any human intervention. The birth and the establishment of computer-managed funds started to raise the concept of the human–robot opposition in trading. This raised the question of which type of trader is currently doing better.

Who Is Doing Better?

If we take a look at both types of traders as an opposition to each other, we will see that the game is quite even.

Eurekahedge’s AI Index, an equally weighted index of 14 constituent funds, designed with the idea to provide a broad measure of the performance of underlying hedge funds, employing AI and ML theory in their trading processes, has been tracking the field since 2011.

hedge fund nidex
(source: eurekahedge.com)

Although the history of returns points out a steady performance, the YTD results indicate that, currently, the AI hedge fund industry is not doing quite well. In fact, for 2018, the index is 7.5% down.

risk return
(source: eurekahedge.com)

To get a better picture of the state of the conflict between robot and human traders, we should take a look at the performance of a particular AI-driven fund – the AI-Powered Equity ETF (AIEQ). The fund is based on IBM’s Watson and is focused on investing primarily in equity securities listed on a U.S. exchange. Although the fund started slowly with a 3.1% average return between the middle of October and the end of last year, compared to a 5.1% return on S&P 500, it slowly gathered pace and is now outperforming the global benchmark.

When it comes to actively-managed funds, S&P’s SPIVA end-of-year scorecard for 2017 points out that for the last 15 years, roughly 95% of hedge funds managers can’t beat the market.

Advice For a New Investor

Due to the fact that the AI-funds industry is still in its early stages, it is hard to tell whether it is capable of outperforming human-managed funds in the long-term. If we should come to a conclusion based on its brief history, the signs are there. The few AI-based funds are already doing better when compared to their human colleagues. All they need now is time.

Of course, long-term investing is just one point of view. As of today, short-term oriented investors like day traders are using much more technology driven trading tools to make their decisions based on fast market movements.

In the past high-frequency trading firms where often in the news. But just because the HFT companies are less frequently in the news in recent months does not mean that the  relevance of high-frequency trading has diminished.

On the contrary, A few large companies dominate the market and are responsible for trading large parts of financial instruments like stocks and commodities.

And it has become much more comfortable for retail investors to make trading decisions based on artificial intelligence algorithms. For example, according to the INC. 5000 list, trade ideas is one of the 5000 fastest growing companies in recent years and offers private investors access to A.I. based trading tools.

Investing as we know it from the past will soon be a thing of the past. More and more machines will take care of our trading decisions and manage our money. This trend is unstoppable and will integrate itself more and more into our everyday life.

Check out Daytradingz.com for more articles by Alexander. If you’ve enjoyed The Focused Investor, sign up to my mailing list to get each new article sent to your inbox. 

Do you write about investing and want to contribute to The Focused Investor? I’d love to work with you! Check out The Focused Investor page to see how.

Adam

About Adam

Hi, I'm Adam! I help millennials invest to reach financial independence sooner than they ever thought possible. Want to see what you could do to reach FI sooner? You're in the right place!

2 Comments

Why not add to the conversation below? Your voice is welcome!

Thank you for the chance to share my experience and point of view about the future of investing with you and your readers. I’m looking forward to the next episodes of this series.

Thanks for being up for it Alex!