What can R2D2 teach you about trading?

by Jul 8, 2016All Articles, Technical Analysis

Darwinian Markets And 800-Pound Trading Gorillas

I am fascinated by change. Sometimes the writing is on the wall while other times it’s abrupt. For example, I’ve worked in the markets for nearly twenty years alongside the evolution of algorithmic trading. I witnessed the Darwinian paradigm shift it brought as those who didn’t evolve were picked off.

Machines began running algos designed and managed by teams of PhDs, with a single-minded purpose —make money trading. It wasn’t personal. The markets are a highly competitive business that rewards evolution.

So, how big has algorithmic trading become? In 2006 ⅓ of all stock trades in the EU and the US were algorithmic. The 2012 CFTC report states that, “Continuing advances in the sophistication of ‘robot’ automated trading technology… are set to continue for the foreseeable future”. They go on, “Today’s markets involve human traders interacting with large numbers of robot trading systems”. Notice the adjective large was used with robots, not humans. Robots are the 800-pound trading gorilla. They are efficient, profitable, and not going away.

Game Over?

How can humans compete against machines? Is it possible to overcome weakness and bias to adjust to the new landscape and succeed?

For humans, our strength, and paradoxically our weakness, is our intuitive nature. We learn from experiences—even just a few (which machines really can’t do well…. yet). Nevertheless, our intuitive nature leaves us vulnerable to costly missteps when participating in financial markets.

Think about all that we can be bombarded with regarding financial markets. News, social media, talking heads, gurus, and many other influences compete for our attention. We need something to help us cut through the noise and get what we need to make clear, unemotional decisions.

An analogy I often use is the working relationship of Luke Skywalker and R2D2. I know, I’m a nerd, but hear me out.

Using computers to reduce noise and make better decisions.

(Above: using computers to reduce noise and make better decisions.)

Luke has done his homework and knows what he’s looking for. The mundane tasks are boring to Luke and make him prone to mistakes. R2D2 performs the complex tasks faster than Luke. R2D2 helps Luke work efficiently by watching for relevant developments requiring Luke’s attention. This keeps Luke from getting overwhelmed or distracted. Luke is free to focus on making good decisions. Luke’s experience-driven insight, plus R2D2’s horsepower are a winning combination.

Garry Recruits R2D2

There is a long history of humans getting beaten by machines. As early as the 1950s, programs begun beating humans at games such as chess. The ultimate blow came in 1996 when Deep Blue from IBM beat the world’s foremost Grand Master, Garry Kasparov. And what was Garry’s reaction? He adapted by coming up with the concept of pairing a human with a computer—each doing what it does best: Luke and R2D2.

This idea caught on and evolved into Advanced Chess, sometimes called Cyborg Chess. Cyborg is a person whose physical and mental abilities are extended beyond normal human limitations. Garry saw the need to extend his capabilities. Now, human and computer teams consistently beat top humans and machines alike.

Fan’s A Fan Of R2D2

Recently, Google’s AlphaGo program dethroned the Go World Champ. But the real story was the warm-up match with the European Go Champ, Fan Hui.

It wasn’t pretty. Fan, pictured below, had his hat handed to him, 0 – 5. Maybe you’ve had a similar experience in the markets?

Fan didn’t quit. He continued playing AlphaGo after his initial defeat, vastly improving his game! He eliminated bad behaviors, stretched himself to think differently, and tried new strategies.

Fan’s game changed revolutionarily and he rocketed up the rankings. This is a perfect analogy for the benefits of using computers to explore, test and refine ideas before investing capital.

Help R2D2 Help You

Humans tend to be intuitive with most things we do. In the past this worked because our competitors were also intuitive. In modern financial markets, against increasingly sophisticated competitors, we need to be more thoughtful and deliberate with our decisions.

Keep the intuitive side—just data-inform it. Like Fan, use that experience and intuition to find new ideas to test. I advocate testing ideas that are seen in the press and social media. Find when the odds are favorable and discard ideas that don’t provide an edge.

Like Garry, extend your capabilities. Use computers for their strengths, like scanning for your vetted ideas or setting up watchlists and alerts. Monitor for the opportunities where you know the probabilities of the moves you’d like to make. Then, make rock-solid consistent decisions.

Is there a learning curve? The answer is yes. But if you are reading this, my sense is that commitment has already been made.

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Carson Dahlberg, CMT

Carson Dahlberg, CMT

Author & Co-founder of Northington Dahlberg Research

Carson comes to Optuma bringing nearly 20 years of experience in the financial markets involved in technical and quantitative trading, research and education. Carson has worked for several notable firms: Morgan Stanley, Wachovia Securities, Wells Fargo, and Schaeffer’s Investment Research. In addition, he is the co-founder of Northington Dahlberg Research, a quantitative driven, volatility-based research firm, and was the Director of the CMTinstitute (an online program to assist financial professionals in the passing of the CMT examination process).

Carson is presently a Director at Large on the Board of the Market Technicians Association and serves the Market Technicians Association (MTA) in various capacities. He was the founder and first Chapter Chair of the Charlotte Chapter for the MTA. His involvement with being the Committee Chair for the Ethics Committee has led to an updated and globally relevant ethics offering for the designation. In the past, he has served on the Admissions Committee, was the Board Liaison for the Journal of Technical Analysis Committee, and was the Director of the CMTinstitute.

Carson received a degree in Chemistry from the University of Cincinnati and was awarded the Chartered Market Technician designation in January of 2008.


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