Automated Trading and the Value Investing
One of the simplest strategies for investing is value investing. This means buying stocks, funds or other assets when the price is low. Since this strategy works best over the long term, many value investors never sell. The most famous and successful value investor is Warren Buffett.
Although value investing is a perfectly viable investing strategy, it does have some bad points. For one, it can be slow. It takes years, or sometimes decades for markets to come down. And then, it can take years for the asset to go back up. It is possible to see the investment double in value in a matter of years, but usually it takes longer.
Another problem with this buy-and-hold strategy is that our downside is huge. During the Great Depression, the markets fell by 90%. Would you be able to hold your positions if your account went down by 90%? Most people are not aware of this, but depressions happen on average once every 80 years. It’s been exactly 80 years since the last depression. I don’t know when we will have another depression, but it is safe to say that it will happen at some point in the not too distant future.
It takes a good deal of learning to make good decisions about which assets to buy. Just because an stock is down by 50% does not mean that it is going to rise back up to its previous levels. In this respect, buying index funds is probably a better idea. But the upside is more limited with an index fund compared to individual stocks.
Automated Trading is in some ways the opposite of buy-and-hold investing. Using an Automated Trading system, a computer program automatically buys and sells for us. When the market is going up, the program can buy. And, when it is going down, sell. No system is perfect, but in some ways, Automated Trading is better than buy-and-hold investing.
One benefit of Automated Trading is that it can automatically liquidate a position when the market moves against us. Instead of holding an asset that has gone down 10%, 20%, 50% or more, an Automated Trading system can sell before the loss becomes large. In this way, these systems can have less risk than more traditional investing strategies.
Another benefit of Automated Trading is that the potential for profit is greater. Since a system can buy or sell more frequently, it can make more money in a shorter period of time. Some systems buy and sell several times during the course of a single day.
Automated Trading systems can take a short position as well. This means that instead of buying a share of stock (for example), the system will borrow shares and sell them. That means that the system can benefit from markets moving down as well as up. Typically markets move down faster than they move up, so the potential for profit is increased.
Some people think that Automated Trading is riskier than buy-and-hold investing. I don’t think that is really true. I think the risk is measured by our knowledge. Someone who buys a stock or mutual fund without knowing about investing is taking on just as much risk as someone who uses an Automated Trading system without getting educated first. Risk is determined by our level of education and experience, not by the instrument that we use to invest.
is one of my favorite financial books of all time. It's an allegory about a guy who has a terrible job, and how he overcomes challenges to achieve his dreams.
