Algorithm as an investment product — Part 1. Method

Since Ed Seikota first automated his futures trading strategy and created algorithmic trading back in 1970’s, much has changed: computers have become commonplace, financial markets have become available to everyone, and 5 thousand dollars of the trader mentioned above became the 15 million. Today, anyone with programming skills can create a trading algorithm. On the other side, however, virtually no retail investor has an opportunity to invest in trading algorithms (we ignore autofollowing on FOREX market due to a number of significant disadvantages of the platforms that offer these services. You can read more about them in our WhitePaper).

How did it happen that something that brings income on financial markets for almost 50 years is still not available to a private investor? So here is the answer: algorithm was and remains, unfortunately, a method of trading rather than investment product. From this statement, which seems unimportant at a first glance, a huge number of vital consequences ensue. To begin with, it should be noted, that people do not invest in methods, but use them for investment. The method of trading (or investing) in financial markets, to make it simple, is a list of actions we carry out trying to analyze markets and make a decision. For example, trading news spreads is a method. Trade in magnetic storms and solar flares is another method (a controversial, but still a method). Same can be said about algorithms today — the trader has programed a code that analyzes markets and makes a decision.

In practice, if some method leads to good results, it offered to a wide range of investors. For example, let’s take the method of investing in a market index. In this case, we believe that a diversified portfolio is the best of what financial markets are capable of at the moment. It is worth noting that this method has passed all tests of time and proved its own significance. But we can not directly invest in a method, as we already mentioned. Previously, you would have to sit and make a list of stocks you would include in portfolio by yourself, calculate correlations, determine weights, etc. Today, however, the relevance of the method led us to index futures, index funds, index options and other instruments on the market whose yield reflects the result of the “investing in the market” method.

There is another method of analyzing the markets — “trust an experienced trader.” In this case, an investor believes that market participants who monitor news during days and nights and whose pulse correlates with price movements will be able to invest money better than the investor himself. Earlier this method consisted in searching for knowledgeable people, consultations and telephone conversations with brokers. Now it’s just another investment product — active funds that recruit experienced managers.

It’s quite interesting, that “trust an experienced manager” method, which experiences significant difficulties with achieving a stable long-term result, has grown into one of the most popular investment products, while trading algorithms that show stable income for already 45 years have not. If you think about it, these methods are very close. Virtually all managers use proven strategies, many of which can be automated. So why, the first became an investment tool, and the second one didn’t?