Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on the fundamentals of successful investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away. Today’s tip: “Those who wish to trade stocks online should be very wary of the promises offered by automated stock trading systems.” Many investment firms manage money with the help of something called a “black box.” This is stock market software that picks stocks or makes other investment decisions, based on historical data. Typically, the software is programmed with algorithms that trigger trades when certain market conditions are met. Individuals sometimes buy these programs over the Internet or from direct-mail advertising. The typical “black box” sales pitch goes something like this:
- Based on decades of research.
- System makes investment decisions automatically—eliminates human emotion and error. Protects profits during market reversals. Makes money for you while you sleep.
- Great track record. Here’s a standard marketing claim: “Well, simple and to the point: if you back-test a robot and it shows 100% ‘demo’ profit in one month, it should PRODUCE around 80-100% profit in LIVE trading. That’s it … no more and no less!”
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The reality: automated systems are built on the past, not the future
Automated systems that make trading decisions for you do two laborious but essentially simple things. First, they narrow down the data you use to make investment decisions. Second, they apply some fixed rule or rules to draw a conclusion or an investment decision from that selection of data. It’s easy to create software that would have made profitable investments in the past. That’s because the programmer has all the data for the period, and can try various combinations of buying and selling rules to see if they would have worked. However, markets are constantly changing. A rule that worked last year may fail miserably this year. Your black box has to compete against other black boxes created this year that also benefit from the latest software and up-to-date market data. These systems often seem to work for a time, but that’s usually coincidental. If the market is going up and they tell you to buy volatile investments, they may generate a series of profitable trades. Then they quit working, and begin pumping out unprofitable trades. Often this happens just when they can do the most damage to their users. Our investment advice: Our response is: be realistic. Stock market software that costs a few hundred dollars won’t make your fortune. The big profits in black boxes go to those who create and sell them to the public, not to those who buy and use them. COMMENTS PLEASE Have you ever looked closely at an ad for an automated trading system or ‘black box’? Did it actually promise to make you rich overnight, or did it simply tell you how great you’d feel if you did manage to get rich overnight? Have you ever attended a free investment seminar on online trading that featured a sales pitch for an automated trading system? Let us know what you think in the comments section below. Click here.
