Why Traders Shouldn't Fight the Machine

Jared Dillian |

“How can you not be romantic about baseball?” asks Jonah Hill in the movie Moneyball, based on Michael Lewis’s 2003 book of the same name. How can you not? I have always liked that thinkers tend to be fond of this game, like the late David Halberstam and George Will and even Keith Olbermann. I loved to play ball, but I was only average. I spent more time in my room playing with statistics, with a pencil and notebook, before the existence of computers and spreadsheets.

It’s not news that the geek squad has taken over the game, probably for good. I don’t even recognize the new statistics—stuff like WAR, BABIP, VORP, and something called PECOTA, Player Empirical Comparison and Optimization Test Algorithm. What? I was a math major, and even I can’t figure this out.

To some extent, it’s diminishing my enjoyment of the game. Seems like they have the infield shift on every other play. I’m sick of watching left-handed power hitters bounce into groundouts into short right field. I miss bunts. I miss stolen bases.

But there is a lot of money at stake here. Not just for the teams, which have finally found a way to quantify talent, but for the sports bettors, like my friend and former Lehman colleague Joe Peta, who found a way to use sabermetrics to great advantage in Vegas, and wrote a book about it.

Igor the Traderbot

There was a point in my career at Lehman, when I was trading index arbitrage, where I pretty much knew that unless I figured out a way to trade algorithmically, I was going to be out of a job.

One, I wasn’t a programmer. Two, I didn’t even know where to start. And three, I doubted Lehman would have put the resources behind it. So I was out of a job.

I was also a floor trader. Those guys lost their jobs too.

There is a huge existential crisis on Wall Street now, especially in equities. Thousands have been laid off. Some guys are still hanging around for a couple of six-figure orders every month so they can make their mortgage payment, but the picture is exceedingly bleak. Usually a bull market means happy sales traders, but not anymore.

The credit guys are still doing well, but they will get what’s coming, someday.

What do you do if you’re a trader and you lose your job to a computer? You are not uniquely qualified to do anything in particular. Some people become insurance agents. Some people open restaurants. Some people work at restaurants.

The beneficiaries are the young kids, the computer science majors who program computers to trade ticker symbols about which they know nothing at all.

It’s a weird situation. The game of baseball has gotten more efficient, and the game of trading has gotten more efficient. It can be tempting to go up against the computers, head-to-head, like day traders do. Don’t do that. You will get your clock cleaned, like Brian Cashman, who admitted at a conference I attended to using sabermetrics only sparingly.

How to Beat the Bots

The one thing computers have yet to figure out in baseball is chemistry. Sometimes players get along, sometimes they don’t, but no computer will be able to quantify its contribution to the number of wins each season. The corrupt, lovable ’86 Mets got along famously. For the last few years, the Yankees have looked like they have as much chemistry as a university history department.

When it comes to stocks, you can’t beat the computers by trading faster (duh), but people try. In fact, having a holding period of anything less than a few days is just madness.

But computers are not clairvoyant. They can’t see the future, but in some cases, people can.

I’m not talking about what the Fed does, stuffing data naively into economy.xls. By 2006, it was obvious to much of the investing community that there was a housing bubble, yet it didn’t become apparent to the Fed (which is basically a computer) until the very end. Sometimes it’s just obvious. The coming Canada bust seems obvious to me. The BOC still sees a soft landing. Go figure. (I explain how to short Canada and how to invest in the US housing market in the last two issues of my investment letter, Bull's Eye Investoryou should check it out.)

Whenever I talk to investors, I always tell them to stretch out their holding period, by months or years. Computers have made things efficient in the short term but have actually contributed to greater inefficiencies in the long term. Before computers, I used to worry about entry and exit points. Now I couldn’t care less. The value is in the idea and the risk management. The execution is worth diddly.

You should be thinking more, and doing less, which goes for just about everything nowadays.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


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