IT’S ALL ABOUT THE ALGORITHM

What is an algorithm?

An algorithm is a fancy word for a procedure, a set of rules designed to accomplish a specific task. It’s a means to that end. Algorithms can be “clean and neat” or “fuzzy and scruffy.” In other words, they may be very accurate, efficient and precise or they may be designed to give the best possible answer to an impossible problem (impossible due to randomness in the system being analyzed.) Fuzzy algorithms exist in nature: ant hills, bee hives, flocks of birds, schools of fish.

Similarly, in regard to modeling the behavior of financial markets, trading algorithms are necessarily fuzzy and based on probabilities. That’s because the market is not deterministic, it just looks that way in hindsight. The majority of volume on the U.S. equity markets is generated by “program trading,” which is algorithmic. Institutions use algorithms to enter and exit positions at the best possible price, feeding their order in piecemeal so as not to disturb the liquidity pool.  

Welcome to 21st Century investing. If you are a self-directed investor I have a question for you. Does the stock market make you nervous?

It should. Since the year 2000 we have already had two extreme bear markets with 50-70% declines… followed by two equally extreme recoveries.

Thank goodness for the recoveries(!!!), and I hope the current one is helping you, but most Mom and Pop investors are not prepared for what I call the New Volatility. This long-term chart of the Dow shows what I’m talking about. 

Today’s markets are more volatile because machines dominate order flow. The global network of high-speed computers and fiber optic pipes exacerbates a natural market phenomena called ‘herding.’ Today, the herd is global, which means the capital flow per unit of time is many times larger than in the 20th century. 

Herding is a follow-the-leader phenomenon. It is a boon during bull phases, because it sustains the uptrend. But when the music stops, herding works against self-directed Mom and Pop investors who are trying to manage their own savings and retirement accounts. 

Each year, the majority of math Ph.D.s are recruited by Wall Street. The machines they program operate algorithmically, that is, with pre-programmed rules. They have no discretion. They buy and sell autonomously and without hesitation. 

In practical terms, it means that Wall Street has become more adept at shaking out the little guy.

Sudden bursts of volatility from 10,000 machines selling all at once create “opportunities” that most human traders and investors shy away from. The largest 1-day down draft ever in the Dow Jones Industrials (more than 1000 points) occurred in August 2015. 

In 2016 we started the year had a month and a half of extreme selling pressure 

It means that 

To keep abreast of the changes, the self-directed investor/trader of today needs to be more nimble and more disciplined.

Frankly, even with the best software (such as Hawkeye), the do-it-yourself investor/trader is at a disadvantage. Studies show that men in particular tend to overtrade, take excessive risks, buy high and sell low. And the behavior gets worse under pressure. The solution is a more automated approach to entries and exists, risk and reward. Algorithms virtually eliminate subjectivity and emotion from trading.

Hawkeye software is already semi-algorithmic; it makes more than 300 calculations per bar simply to generate it’s volume signals. Hawkeye ETF goes a step further, filtering out the noise and sending you objective signals in a very timely manner via email and text messages.

By the way, at Hawkeye ETF we don’t usually day-trade, but we do use intraday signals to get into an advantageous position in a timely manner… usually ahead of the crowd.


WHAT WE TRADE

There is virtually an ETF for every investment niche… more than 2000… but don’t waste your time sorting through them. Despite the neat names, most have some defect that makes unsuitable for active traders.

The ETFs that interest us  for short-term swing trading are the leveraged ETFs. These are ETFs that move 2-3 times compared to the standard unleveraged versions. Leverage is one way hedge funds attempt to capture “alpha,” which is out-performance vs. a benchmark.

 

But you’d better know what you are doing, since most of the leveraged instruments have serious tracking errors. And in my view the majority of Inverse leveraged ETFs, which go up in a down market, are virtually useless.

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