Reprintedfrom
fromthe
theEconomist,
Economist,January
March 1987
Reprinted
3rd 2015
Finance brief
they have gained ground as a tool of technical economic conditions that underlie them.
analysis.
technical
analysis ofthe
financial
markets Chartists
Computers
challenge
stockmarket
gurus look for recognisable patterns that
starts with the assumption that markets follow suggest the future direction of the price of a
trends determined by previous patterns of price financial instrument. Computers sift historical
Reprinted
the Economist,
2015 sets of events. Work
behaviour, and rarely, if ever,
move from
randomly.
data toJanuary
look for 3rd
repeatable
imagine the different types of traders in out the past probability of a sequence of events,
a financial market. Each has a different set of and you might have hit upon the probability of
expectations of how the price will move and future events.
of how long to hold his investment. a “local”
a computer trading system takes a chartist’s
Plugged
dealing
on in
work one step further. by finding a set of rules
his own account on the floor of a futures which can be tested against past performance,
Program trading used to mean buying and selling large baskets of stock as if they were
exchange
might
buy and
during refers
the same
it attempts
to spot
future trend
from a
individual
shares.
now,sell
it usually
to arbitrage
between,
say, aa stock-index
futures
day;contract
a commodities
trader and
might
combination
pastonprice
movements
traded in Chicago
thethink
sharesofof 500
companiesof
listed
the new
york stockand
Exchange
that underlie
holding
his investment
forit.two or three days; other statistical data that it is fed. if a financial
suppose
that an
investor
has a batch
of shares
worthfor
$10m.
could hold
a private
speculator
forindividual
perhaps two
or three
instrument
is held
longheenough,
there
on to them and pocket the dividends paid on them. Or he could sell the shares, invest the
weeks; a mining company hedging against the is a certain historic probability of the price
money instead in treasury bonds, and buy them back in three months’ time. assuming that
possibility
of an
ill-timed
movement
price,
repeating
itself.
the computer
issues
the interest
received
from
investingin
the
moneymovement
in the meantime
in the
money
markets was
for greater
severalthan
months.
their different
perceptions
buy and
signals
when
it spotsthe
such
a pattern
the dividends
to be gained
from owning
the sell
same
amount
of shares,
investor
could
better in
offdifferent
at the endways.
of three
as the commodity
put it,
would to
affect
thebemarket
themonths.
job of Or,
reappearing.
a funddealers
manager
hashemerely
have saved
himself
theidentify
“cost ofacarry”.
a technical
analyst
is to
break in the follow its commands.
the opposite of this is the kind of program trade which causes problems at the “triple
trend
and the start of a rise or fall in the price.
several ways of spotting profit able breakouts
witching hour”. that is when (as happened on March 20th) contracts on stock-index futures, on
the
reason
for
dealing
in
futures
in
are
followed.
some
look them
at moving
averages
stock-index options and on the options of the individual
shares that
underlie
expire at
the
which
investors
same
time. undertake to buy or sell on a of prices, and movements above or below that
a program
trader
willthe
buylosses)
shares which
make
up themeasure
index, either
by buying of
all the
future typically,
date, is that
the gains
(and
average.
Others
the momentum
shares in itmuch
or-more
likelybecause
because of
follows
these shares
arethe
potentially
greater
of the
thecost-a
fall selection
or rise in that
the price
onthem.
a chart.
are then sold to fulfil the seller’s obligations when the futures contract that represents them
leverage
that these markets allow. (Often as
Mr David harding of adam, harding & Lueck,
expires. With luck, the premium over the market price of the futures contract will more than
computer
boaststhat
a specializes
cumulative
little
as
tenth
of
of
futures
contract ainbritish
firm oftrading,
fund managers
hyais
Citibank,
the
world’s
most profitable
compensate
forthe
thevalue
cost
of a
carry.
ato
computer
must monitor
the prices of
the futures
contracts
those
the
underlying
increase
intrading,
theand
value
ofof
mutual
funds
(the
needs bank,
bespending
pledged
as a developing
down-payment).
in
futures
looks
for
rates
of change
$20m
what
it must
calculate
the liquid
cost of
carry,
work
out
whether
the two
prices
american
equivalent
british
unit
trusts)
Futures
arecomputer
usually
very
(i.e.,
in
the
price
pattern
oforaofnot
market.
his
computer
it securities.
calls markets
“expert
systems”?
Why
is and
are out of line. that done, it must help the trader decide on the cheapest way of executing
under its
in the
to the
their
turnover
is high);
andbig
investors
in them
notmanagement
only generates
buy five
and years
sell signals
Morgan
Guaranty,
another
new york
bank, system
the course it recommends.
end
of
1985
of
218%.
that
compares
with
do
notProgram
have
take
delivery
of
the
underlying
when
the
price
shifts
significantly.
it
also
shows
spending
antoundisclosed
sum
(probably
more)
trading is carried our mostly by investment banks for their big institutional an
average
increase
for the
funds
stock,
currency
commodity.
Futures
markets
long
an
investment
should
bemutual
held.
onclients.
the
same
arcane
thing?
answer:
mainly
Profitor
margins
on such
trades
used to how
be
as
much
as 3% above
the905
cost
of carry.
they
are
now
down
togo
0.5%.
this
is
mainly
because
increase
in program
trading
in
recent
over
the
same
period
ofin91.7%.
also
enable
investors
to
short
asthem
well
as
long
athe
matrix
shows
the
probability
a particular
because
they
and
other
banks
like
want
to measured
years has
caused
markets
to
moreand
efficient.
if of
traders
switched
their
extensive
true,
fund
managers
have
achieved
similar
(investors
can
sell stock
they
dothem
not how
own
in
market
any given
priceoff
movement
occurring
develop
computers
that
will
tellbecome
hardware, the markets would become slack again, and the opportunities for making money
(and a often
no map,
more
the
hope
of buying
they lack at a markets.
cheaper over
when
to deal
in thewhat
foreign-exchange
certainbetter)
period.returns
Like a with
contour
in them would increase.
a pencil
pad of known
paper. as
but“hills
few
price,
thusis making
on the difference
their aim
to devisemoney
computer-trading
systems itthan
displays
whatand
are a(tweely)
have
succeeded
in reducing
the where,
risk of iftheir
that
will
reduce
the
risk
of
dealing
in
lumps
between
the
two).
of
good
ness”.
these
are
spots
an
money invested a year. to that must be added their success is achieved largely because the
investments
as well
those
funds
that
rely
of fast-moving
exchange
among gains
investment
is held
(usually
for
between
twomore
and
management
feesforeign
of around
6%. soby,
a futures
from spotting
a as
good
trend
usually
ondays),
computers
tell
them
when
and markets
what to
otherusually
things, needs
throwing
buyaand
sell signals
Chart
topper
25
it usually
proves
profitable.
fund
to up
show
return
on its than
offset
thetolosses
incurred
when
investment
of at
least
25%
a year
to break
even.
sideways.
it is alsoand
because
buytesting
and
sell.
whenever
they
detect
a significant
shift
in
the drift
to
understand
what
is required
of the
computers
hypotheses
findingdisinflation
workable
Most
do.
Critics
say
thiswhen
is because
the has
allowed
investors
to
make ismoney
in
the within
United
states,
about
30
pattern
currency
that
are of
designed
tovalues.
predict
to buy and
boundaries
which
to invest
thesecurities
firstfrom
and
fad for computer trading has emerged during falling commodity prices. Mr harding reckons
firms
managing
about
$4
billion-worth
of other
Computers
capable
of
match
ing
the
lightning
sell
in these markets, look first at traditional main task for computers used by funds investing
the greatest bull market since the roaring that, although only 50% of system trades are
people’s
already
sell
largely
on
reactions supporters
top foreign-exchange
dealer,
let profitable,
methods
of a technical
analysis.
the
most
in
futures.money
to
be successful,
aand
computer
trading
twenties.
of the
funds retort
that
these
are onbuy
average
three
times
the instructions
alone improving
on them,
do not exist-yet.
the system
popular
form is chartism.
a chartist
will attempt
must be: of a computer trading system.
britain,
the amountrobust.
managed
with the
closest
things
at thebymoment
arerecognisable
the systems in •
to
discern
a trend
spotting
Mathematically
Mr Larry
hite,aid
a
muchlikens
smaller
($15m),to but
used increasingly
the offund-management
movements
in the byprice
a security or of computers
partner is
of Mint,
a computer
an
in neither
country
should the
firms that specialise
in investing
the futures
commodity
which confirm
a “breakinout’’,
either growing.anvil.
ideas can
be hammered
out deals
on it
aid of these
systems
confused
markets
of such
as treasury
up
or down,
fromthings
the range
withinbonds,
whichstock
the done with
andthe
discarded
if they
do notbe
come
up to
with program
trading, which in america means
indexes,
currencies been
and aluminium.
price
has previously
trading .
scratch.
between
a futures
market
and its
it istechnical
hard to divine
trends
markets,
all
analysis
has in
inthese
common
the arbitrage
• broad
in scope.
a system
that worked
cashthe
market
(see box
on next
but profitable
when itdisplay
can be characteristics
done. Mint, an underlying
belief
that markets
during
inflationary
1970s
mustpage)
also
means
dealings
large
blocks
american
firmdetermined
of fund managers
specialises and in britain
that
are not
by thethat
fundamental
be capable
of coming
to in
terms
with
the
W
disinflationary 1980s.
Extrapolating future price movements from
past ones can be tricky. a computer can assist
in calculating the probability of a certain price
movement being repeated; it can judge the
Wave power
probable
risk of any investment; and it can
guess how much money should be invested, and
are several
ways of forecasting
for there
how long
that investment
should be from
held, to
the pattern
andrate
movement
of prices where
achieve
a certain
of return.
financial markets will go. the most widely
used
and the oldest is chartism. it started
Risk
averse
winning managers
disciples at
beginning
of thenot
successful
ofthe
funds
are rigorous
Mosttheir
securities
firmstheories,
now havebut
onlycentury.
in testing
computer
team
plottingthe
share-price
movements
alsoa in
spreading
risk involved.
this means
to predicttheir
whether
they will over
go upseveral
or
diversifying
investments
down. their
Chartism’s
seniority
given
it
markets.
first aim
is tohas
limit
possible
a
respectability
lacking
in
other
forms
of
losses. because of the high level of gearing (the
technical
analysis. One
reason for
is
value
of the investment
compared
to this
the down
that
markets
in
equities,
oninwhich
chartism
more
profitable
than
the losses.
payment
required)
allowed
futures
markets,
there
snags.
isexisted
that, iffor
everybody
is
most
often
used,One
have
much
levels
are are
set
at
which
investments
are
sold and
is longer
following
the in,
same
theory,
computer
than those
say, futures
or options.
so
losses
stopped.
trading systems become self-defeating. the
neither
back
as far
as the various
Most
fundsgoes
spread
their
investments
over at
opportunities
for making
money diminish
if
cycle
theories.
the
most
famous
these
everybody
jumps atand
the usually
same signals.
that
is this
one
least ten markets
manyof
more.
is the
kondratieff
long
wavetointo
theory,
reason
for the
secrecy
over
research
expert
is not
easily
done.
Markets
tend
be related
systems
eyeing thecentury
potential
named
afbig
terofbanks
the
nineteenth
(e.g.,
thebyprice
gold
is
often influenced
by
profits
to beeconomist
made from
spotting
trends
in the
who
hit
upon
thatRussian
of the dollar).
Even
thefirst
managers
of it.
funds
foreign-exchange
markets.
he ascribed
the behaviour
of prices,
asset for
specialising
in futures
admit
that
it isthat
unwise
the banks
will face
problems
their
values and
warring
societies
todo
afutures.
50-60counterparts
in
futures
not. One
an investor
to trading
put
all his
money
into
year
cyclebywill
ofthe
booms
and
if true,
thethat
is that
they
not
the
protection
a study
latehave
Johnbusts.
Lintner
of harvard
diversification
currently
affords
funds.
next bust
should
at thefutures
end of
the
University
found
thatoccur
an investment
portfolio
a bonussince
for the
however,
is the afact
thebanks,
lastasone
wasasinequities
1929.
that1980s,
contained
futures
well
and
that,
because they
make
up
the market, their
more
up-to-date
version
of
the
“superbonds produced
better
return,
the same
dealing
fees willa be
much
lower.forthey
must
cycle
theory”
is up
that
bythey
the
nonetheless
be
hoping
that
the money
are
risk,
as one
made
of produced
equities
and
bonds
bankLintner
Credit
analyst,
a Canadian
research
spending
on the
next generation
or
computer
alone.
measured
the risks
involved
trading
systems
will give
them
aneffects
extra edge.
outfit.
it worries
about
offunds
a
in investing
in a sample
of the
23 managed
build-up
of
liquidity
in
the
banking
system.
over the three years to 1982. to measure the
Wave
heor iesa required
of s tockmarke
t
historical
risktagainst
rate of return
movements
are
based
on
similar
principles.
(the risk reward ratio), he calculated the
the one
thatofhas
the widestinvestment
following,and
average
return
a particular
the Elliott
charted by
the
divided
it by wave
the theory,
averageismonthly
deviation
reclusive
Mr.
Robert
Prechter.
he
thinks
from that return.
that
financialinmarkets
followshown
a fiveFundsthe
investing
futures have
high
wavepartly
pattern
with a three-wave
correction
returns
because
bonds
and
shares
on the
© the Economist newspaper Limited, London (1987)
if Mrfutures
Prechter
the
Dowoneperiod.
hand, and
on is
theright,
other,
tend
to do
Jones
lndustrial
index
will
reach
3,700
well at different times. as these markets allow
before to
falling.
Vexingly
hisenable
followers,
he
investors
go short,
theyfor
also
investors
has
yet
to
work
out
when
this
will
happen.
to profit from falls as well as rises in the market.
a fund that invests almost exclusively in
of shares.
Computers,
of course,
have along
futures
might
trade around
30 times
yearhad
in
a roleofinperhaps
securities
commodities
markets.
each
40and
markets.
such churning
but it is only
the past
five years
that broking
(thanks
generates
(tointhe
brokers’
delight)
to the
advance20%
in of
data
fees
of perhaps
the processing
total value power)
of the
PLUS ÇA CHANGE,
PLUS C’EST LA
MÊME CHOSE
By David Harding, May 2015
“...THE ESSENCE OF TREND FOLLOWING
HAS BEEN EFFECTIVE BEYOND MY WILDEST
DREAMS AND, FOR ME IT HAS BEEN MORE
The Economist Article from March 1987 was at least partly
stimulated by my acquaintanceship with a journalist at the
magazine; a friend of a friend from college who was able
to leverage a substantial piece of financial journalism off the
fledgling Adam, Harding & Lueck. I am certain that he and I
would never have thought for one moment that that company
would still be thriving 27 years later having grown to more
than 2000 times the size! (To say nothing of the existence of
the much larger Winton and other ‘spawn’ of AHL.)
The approach described in the article to running computer
trading systems is essentially the same today as it was then
(indeed the chart of £/$ illustrating the article is the same chart
exactly as the opening chart in my presentation today). It has
truly withstood the test of time. However, the journalist wasn’t
exaggerating when he said that the futures fund of the time
had to make at least 25% to break even, and that probably
didn’t even take full account of what we now call slippage – the
amount we move the market getting into and out of trades.
Ironic then, that while trend following systems were producing
such exorbitant gross profits, financial market academics
were fleshing out the theory of why such profits would be
theoretically impossible to achieve. Masked by the high fees
and costs and by the inherent improbability that technical
analysis and systematic trend-following should be of any
profound importance, the world sailed on its growing acceptance
of ‘efficient markets’, untroubled by the reproach offered by the
continued success of such systems.
The warning offered by the journalist, that such systems were
liable to be self- defeating, proved to be much, much too soon.
It was a reasonable voice of caution and scepticism but it proved
misleading, as have its many echoes down the years. There
is further irony in the fact that the main anxiety prospective
investors have about the methodology remains unchanged
over such a long period. Perhaps the sceptic’s warnings of too
much money following the same strategy will have force one
day, but they have been persistently wrong so far. Indeed one
RISKY TO DIVERSIFY AWAY FROM IT...”
might wonder why they consistently see systematic traders as
more likely to act homogeneously than human ones where the
evidence of crowd behaviour is much more tangible.
Anxious myself about this undeniable and credible argument
I have been constantly motivated to research and discover
new approaches to trading and investing over the intervening
years and the computer aided method of analysis has proven
its worth. However, the essence of trend following has been
effective beyond my wildest dreams and, for me it has
been more risky to diversify away from it than to embrace it
wholeheartedly. In my career I have remained loyal enough to
it to have benefited mightily from its sustainability, albeit having
steadily ratcheted down the aggressiveness of the trading in
terms of both trading activity and leverage. As the years have
unfolded and I have had experience of the seemingly magical
phenomenon of trends, my prejudice in favour of this unloved
and unheralded investment approach has hardened. To a
statistician this is called a Bayesian Philosophy. You start with
your prejudices and modify them in the light of experience.
I started with a weak belief in trend following because
conventional opinion said it couldn’t work. As I saw it work
year after year my belief in it has hardened and I have sought
explanations as to why the conventional orthodoxy was wrong.
Over the years, it is the orthodoxy that has gradually come
to seem ridiculous; that market movements can be perfectly
described by the heat diffusion equation from physics, that
the movements of market prices are analogous to the buffeting
of smoke particles by the invisible atoms in a gas (Brownian
Motion). How much more credible does it seem that the
movements of markets should be the subject of a somewhat
arcane social science which uses modern computational
techniques to build and evaluate models in a simulated
parallel reality?
How fortunate for me therefore, that driven by a mixture of
entrepreneurial drive, greed, curiosity and desperation I have been
able to build companies by exploiting this philosophical
misunderstanding of modern markets. My success has been founded
on the globalisation of financial markets and the information
technology revolution. From small acorns, mighty oaks grow!
Reprinted from the Economist, March 1987
1987
Reprinted from the Economist, March
January
3rd 2015
Finance brief
Finance brief
Reprinted from the Economist, March 1987
Reprinted from the Economist, January 3rd 2015
Computers challenge the stockmarket gurus
Finance brief
Computers challenge the stockmarket gurus
W
hy is Citibank, the world’s most profitable
bank, spending $20m developing what
it calls “expert
computer systems”? Why is
Morgan Guaranty, another big new york bank,
hy isan
Citibank,
the world’s
most profitable
spending
undisclosed
sum (probably
more)
bank,
spending
what
on the
same
arcane $20m
thing? developing
answer: mainly
it
calls
“expert
computer
systems”?
Why
is
because they and other banks like them want to
Morgan
york
develop Guaranty,
computersanother
that willbig
tellnew
them
howbank,
and
spending
an undisclosed
sum (probably
more)
when to deal
in the foreign-exchange
markets.
on
the
same
arcane
thing?
answer:
mainly
their aim is to devise computer-trading systems
because
and the
otherrisk
banks
like theminwant
to
that willthey
reduce
of dealing
lumps
develop
computers
that will
tell them
and
of fast-moving
foreign
exchange
by,how
among
when
deal in
the foreign-exchange
other to
things,
throwing
up buy and sellmarkets.
signals
their aim isthey
to devise
whenever
detectcomputer-trading
a significant shiftsystems
in the
that
willofreduce
the
risk of dealing in lumps
pattern
currency
values.
of Computers
fast-movingcapable
foreign
exchange
by,lightning
among
of match
ing the
other things,
up buy and sell
signals
reactions
of a throwing
top foreign-exchange
dealer,
let
whenever
they detect
a significant
shift in the
the
alone improving
on them,
do not exist-yet.
pattern
of currency
values.
closest things
at the
moment are the systems
Computers
capable
match
ing the lightning
used
increasingly
byofthe
fund-management
reactions
a top foreign-exchange
dealer,
let
firms that of
specialise
in investing in the
futures
alone
improving
on
them,
do
not
exist-yet.
the
markets of such things as treasury bonds, stock
closest things
at the
moment
are the systems
indexes,
currencies
and
aluminium.
used
by trends
the fund-management
it isincreasingly
hard to divine
in these markets,
firms
that specialise
in theMint,
futures
but profitable
when in
it investing
can be done.
an
markets offirm
such
as treasury
bonds,
stock
american
ofthings
fund managers
that
specialises
indexes, currencies and aluminium.
it is hard to divine trends in these markets,
but profitable when it can be done. Mint, an
american firm of fund managers that specialises
W
in computer trading, boasts a cumulative
increase in the value of mutual funds (the
american equivalent of british unit trusts)
under its management in the five years to the
in
boasts
a cumulative
end computer
of 1985 oftrading,
218%. that
compares
with an
increase
in
the
value
of
mutual
funds funds
(the
average increase for the 905 mutual
american
equivalent
of
british
unit
trusts)
measured over the same period of 91.7%.
under
itsfund
management
the five
years similar
to the
true,
managersinhave
achieved
end
of
1985
of
218%.
that
compares
with
an
(and often better) returns with no more
average
increase
for
the
905
mutual
funds
than a pencil and a pad of paper. but few
measured
over theinsame
periodthe
of 91.7%.
have succeeded
reducing
risk of their
true,
fund
managers
have
achieved
similar
investments as well as those funds that
rely
(and
often
better)
returns
with
no
more
on computers to tell them when and what
to
than
a sell.
pencil and a pad of paper. but few
buy and
have
reducing
the 30
risksecurities
of their
in succeeded
the Unitedinstates,
about
investments
as
well
as
those
funds
that
rely
firms managing about $4 billion-worth of other
on
computers
tell them
andlargely
what on
to
people’s
moneytoalready
buy when
and sell
buy
and
sell.
the instructions of a computer trading system.
in the United
states,
about 30
securities
in britain,
the amount
managed
with
the aid
firms
managingisabout
$4 billion-worth
of other
of
computers
much
smaller ($15m),
but
people’s money
already
buy and
sell largely
on
growing.
in neither
country
should
the deals
the
instructions
of
a
computer
trading
system.
done with the aid of these systems be confused
in britain,
the
amountwhich
managed
with the
aid
with
program
trading,
in america
means
of
computers
is
much
smaller
($15m),
but
arbitrage between a futures market and its
growing.
neither
country
should
the page)
deals
underlyingincash
market
(see box
on next
done
the aid
of these
systems
confused
and inwith
britain
means
dealings
in be
large
blocks
with program trading, which in america means
arbitrage between a futures market and its
underlying cash market (see box on next page)
and in britain means dealings in large blocks
Wave power
there are several ways of forecasting from
the pattern and movement of prices where
Wave
power
financial
markets will go. the most widely
used and the oldest is chartism. it started
there
aredisciples
several ways
of beginning
forecastingoffrom
winning
at the
the
the
pattern
andsecurities
movementfirms
of prices
century.
Most
nowwhere
have
financial
marketsshare-price
will go. the most
widely
a team plotting
movements
used
and
the
oldest
is
chartism.
it
started
to predict whether they will go up or
winning
disciples atseniority
the beginning
of the
down. Chartism’s
has given
it
century.
Most securities
have
a respectability
lacking infirms
othernow
forms
of
atechnical
team plotting
share-price
movements
analysis.
One reason
for this is
to
they
will go
up or
thatpredict
marketswhether
in equities,
on which
chartism
down.
hasfor
given
it
is mostChartism’s
often used,seniority
have existed
much
alonger
respectability
lacking
in
other
forms
of
than those in, say, futures or options.
technical
One
forvarious
this is
neitheranalysis.
goes back
as reason
far as the
that markets
in equities,
which chartism
cycle
theories.
the mostonfamous
of these
is
often used, have
much
is most
the kondratieff
longexisted
wave for
theory,
longer than
those
in, nineteenth
say, futures orcentury
options.
named
af ter
the
neither
goes backwho
as far
ashit
theupon
various
Russian
economist
first
it.
cycle
theories.
the
most
famous
of
he ascribed the behaviour of prices, these
asset
is the and
kondratieff
long wave
values
warring societies
to atheory,
50-60named
afof
terbooms
the nineteenth
century
year cycle
and busts. if true,
the
Russian
whoat
first
upon
it.
next busteconomist
should occur
thehit
end
of the
he ascribed
prices,
asset
1980s,
sincethe
thebehaviour
last one of
was
in 1929.
a
values
and warring
societies
to a“super50-60more up-to-date
version
of the
year
of booms
and produced
busts. if true,
the
cyclecycle
theory”
is that
by the
next bust
occur
at the end
of the
bank
Creditshould
analyst,
a Canadian
research
1980s,
since
the last
onethe
waseffects
in 1929.
outfit. it
worries
about
of aa
more
up-to-date
version
of
the
“superbuild-up of liquidity in the banking system.
cycle
theory”
is ies
that of
produced
by thet
Wave
t heor
s tockmarke
bank
Creditare
analyst,
a Canadian
research
movements
based on
similar principles.
outfit.
worries
the effects
of a
the oneit that
has about
the widest
following,
build-up
of wave
liquidity
in theisbanking
the
Elliott
theory,
chartedsystem.
by the
Wave Mr.
t heor
ies Prechter.
of s tockmarke
reclusive
Robert
he thinkst
movements
are
based
on
similar
principles.
that the financial markets follow a fivethe one
thatwith
hasathe
widest following,
wave
pattern
three-wave
correction
the
Elliott
wave
theory,isisright,
charted
the
period.
if Mr
Prechter
thebyDowreclusive
Mr.
Robert
Prechter.
he
thinks
Jones lndustrial index will reach 3,700
that the
financial
markets
a fivebefore
falling.
Vexingly
for hisfollow
followers,
he
wave
pattern
with
three-wave
correction
has yet
to work
outawhen
this will
happen.
period. if Mr Prechter is right, the DowJones lndustrial index will reach 3,700
of before
shares.falling.
Computers,
of for
course,
have long
Vexingly
his followers,
hehad
a role
in
securities
and
commodities
markets.
has yet to work out when this will happen.
but it is only in the past five years that (thanks
to the advance in data processing power)
of shares. Computers, of course, have long had
a role in securities and commodities markets.
but it is only in the past five years that (thanks
to the advance in data processing power)
they have gained ground as a tool of technical economic conditions that underlie them.
analysis. technical analysis of financial markets Chartists look for recognisable patterns that
Computers challenge the stockmarket gurus
starts with the assumption that markets follow suggest the future direction of the price of a
trends determined by previous patterns of price financial instrument. Computers sift historical
they
have gained
ground
as amove
tool randomly.
of technical economic
that
behaviour,
and rarely,
if ever,
data to lookconditions
for repeatable
setsunderlie
of events.them.
Work
analysis.
technical
analysis types
of financial
markets
look
for recognisable
patterns
that
imagine
the different
of traders
in Chartists
out the past
probability
of a sequence
of events,
starts
with market.
the assumption
markets follow
the future
of the
price of ofa
a financial
Each hasthat
a different
set of suggest
and you might
have direction
hit upon the
probability
trends
determined
by previous
of price
instrument. Computers sift historical
expectations
of how
the pricepatterns
will move
and financial
future events.
behaviour,
and
if ever,
move randomly.
look fortrading
repeatable
setstakes
of events.
Work
of how long
torarely,
hold his
investment.
a “local” dataa to
computer
system
a chartist’s
imagine
past
probability
of afinding
sequence
of of
events,
dealing
on the different types of traders in out
workthe
one
step
further. by
a set
rules
a financial
has floor
a different
set of and
you
might
have hit
uponpast
the probability
of
his own market.
accountEach
on the
of a futures
which
can
be tested
against
performance,
expectations
of how
the sell
priceduring
will move
and future
events.to spot a future trend from a
exchange might
buy and
the same
it attempts
of
howa long
to hold his
investment.
“local”
a computeroftrading
a chartist’s
day;
commodities
trader
might athink
of combination
past system
price takes
movements
and
dealing
on
work
one
step
further.
by
finding
a
set
of rules
holding his investment for two or three days; other statistical data that it is fed. if a financial
his ownspeculator
account on
floor two
of aorfutures
can beistested
pastenough,
performance,
a private
for the
perhaps
three which
instrument
held against
for long
there
exchange
might buy
and sell
during
the same
spot probability
a future trend
weeks; a mining
company
hedging
against
the it
is aattempts
certain to
historic
of thefrom
pricea
day;
a
commodities
trader
might
think
of
combination
of
past
price
movements
and
possibility of an ill-timed movement in price, movement repeating itself. the computer issues
holding
hismonths.
investment
two or perceptions
three days; other
statistical
data
thatititspots
is fed.such
if aafinancial
for several
theirfor
different
buy and
sell signals
when
pattern
aaffect
private
for perhaps
twothe
or job
three
long enough,
there
the speculator
market in different
ways.
of instrument
reappearing.isa held
fund for
manager
has merely
to
weeks;
a
mining
company
hedging
against
a certain
historic probability of the price
a technical analyst is to identify a break in the
the is
follow
its commands.
possibility
of start
an ill-timed
in price.
price, movement
itself. profit
the computer
issues
trend and the
of a risemovement
or fall in the
several repeating
ways of spotting
able breakouts
for the
several
months.
different
perceptions
sell signals
spots
such aaverages
pattern
reason
for their
dealing
in futures
- in buy
are and
followed.
somewhen
lookitat
moving
affect
marketundertake
in different
fund manager
merelythat
to
which the
investors
to ways.
buy orthe
selljob
on ofa reappearing.
of prices, and amovements
abovehas
or below
afuture
technical
to gains
identify
a break
in the follow
its Others
commands.
date,analyst
is that isthe
(and
the losses)
average.
measure the momentum of the
trend
and the start
of agreater
rise or fall
in the of
price.
ways
spotting
are potentially
much
because
the fallseveral
or rise in
theofprice
on a profit
chart.able breakouts
the reason
for dealing
futures
- as
in are Mr
followed.
some of
look
at moving
leverage
that these
markets in
allow.
(Often
David harding
adam,
harding averages
& Lueck,
which
investors
undertake
to
buy
or
sell
on
a
of
prices,
and
movements
above
below
that
little as
a
tenth
of
the
value
of
a
futures
contract
a
british
firm
of
fund
managers
specializes
aor cumulative
hy is Citibank, the world’s most profitable in computer trading, boasts that
future
date,
is pledged
that the$20m
gains
(and
the losses)
average.
momentum
of(the
the
needsbank,
to bespending
as
a developing
down-payment).
in futuresOthers
looks
for
rates funds
of change
intrading,
the measure
value
ofthe
mutual
what increase
are
potentially
greatersystems”?
because
of(i.e.,
the
fall
or rise
the price
abritish
chart. his
Futures
marketsmuch
are
usually
very
liquidWhy
in the
pricein
pattern
ofon
a market.
equivalent
of
unitcomputer
trusts)
it calls
“expert
computer
is american
leverage
that these
markets
allow.
(Often
as under
Mr David
harding
of adam,
Lueck,
their
turnover
is high);
andbig
investors
in bank,
them
system
notmanagement
only
generates
buyharding
andyears
sell&signals
its
in the
five
to the
Morgan
Guaranty,
another
new york
little
ashave
a tenth
of
thedelivery
valuesum
of of
a(probably
futures
contract
awhen
british
firm
ofshifts
fund
managers
that
do
not
take
the underlying
priceof
significantly.
it specializes
also
shows
ofthe
1985
218%.
that compares
with
an
spending
an to
undisclosed
more) end
needs
tosame
be pledged
as a down-payment).
in
looks
for
of change
stock,
or commodity.
Futures
howfutures
long increase
antrading,
investment
should
bemutual
held.
for
the
905rates
funds
on thecurrency
arcane
thing?
answer: markets
mainly average
Futures
markets
usually
very
liquid
in the
price
pattern
ofprobability
aperiod
market.
hisa particular
computer
also
enable
to
go short
well want
as(i.e.,
long
a matrix
shows
over
the the
same
of in
91.7%.
because
theyinvestors
and are
other
banks
likeasthem
to measured
their
turnover
high);
and
investors
inown
them
only
generates
buyachieved
and sell
signals
(investors
can issell
stockwill
they
do
nothow
in system
market
offund
any
given
pricehave
movement
occurring
true,not
managers
similar
develop
computers
that
tell
them
and
do
not
to
delivery
theatunderlying
when
pricebetter)
shifts
significantly.
it also
the
hope
of buying
theyof
lack
amarkets.
cheaper (and
over athe
certain
period.
Like awith
contour
map,
often
returns
no shows
more
when
tohave
deal
in take
thewhat
foreign-exchange
stock,
currency
or commodity.
markets than
how
long
anwhat
investment
should
be held.as
price,
thus
making
money
onFutures
the difference
it displays
area (tweely)
a pencil
and
pad
of known
paper.
but“hills
few
their aim
is to
devise
computer-trading
systems
also
investors
go of
short
as well
long have
a matrix
shows
probability
a particular
between
two).the to
of good
ness”.
these
are spots
an
succeeded
inthe
reducing
the inwhere,
risk
of if
their
that enable
will the
reduce
risk
dealing
inaslumps
(investors
can sell
stockexchange
they do not
in investments
market
of any
given
price
movement
investment
isas
held
(usually
for between
two rely
and
well
as those
funds occurring
that
of fast-moving
foreign
by, own
among
the
hope
of buying
whatupthey
a cheaper
over
a certain
Like
a contour
map,
Chart
topper
25 days),
it usually
proves
profitable.
computers
toperiod.
tell
them
when
and what
to
other
things,
throwing
buylack
andatsell
signals on
price,
thusthey
making
onofthe
difference
it displays
are (tweely)
known workable
as “hills
to
understand
what
ismoney
required
theshift
computers
testing
hypotheses
and finding
and sell.what
whenever
detect
a significant
in the buy
between
two). to
good
are
spots is
where,
an
that
areofthe
designed
predict when to buy and of
boundaries
withinthese
which
to about
invest
the
firstifand
in theness”.
United
states,
30
securities
pattern
currency
values.
investment
is
held
(usually
for
between
two
and
sellComputers
in these markets,
look
first
at
traditional
main
task
for
computers
used
by
funds
investing
capable of matching the lightning firms managing about $4 billion-worth of other
Chart
topper
25
days),money
itto
usually
proves
profitable.
methods
ofa top
technical
analysis. the
most
in futures.
be already
successful,
aand
computer
trading
buy
sell largely
on
reactions
of
foreign-exchange
dealer,
let people’s
to
understand
required
of the
computers
testing
and finding
popular
form iswhat
chartism.
ado
chartist
will
attempt
system
musthypotheses
be: of a computer
instructions
tradingworkable
system.
alone
improving
on is
them,
not
exist-yet.
the the
that
arethings
designed
to by
predict
when
to buy
and in
boundaries
within
which robust.
to investMriswith
the first
and
to
discern
a trend
spotting
• Mathematically
Larry
hite,
britain,
the amount
managed
the
aida
closest
at the
moment
are recognisable
the
systems
sell
these in
markets,
look
traditional
main
taskpartner
for computers
bya funds
investing
movements
thebyprice
of
aatsecurity
or of
Mint, used
likens
computer
tobut
an
computers
isof much
smaller
($15m),
usedinincreasingly
the first
fund-management
methods
ofwhich
technical
analysis.
thefutures
most growing.
in futures.
be
successful,
a should
computer
trading
commodity
confirm
a “breakinout’’,
either
anvil.
ideas
can
be hammered
out
on it
intoneither
country
the
deals
firms that specialise
in investing
the
popular
form
is chartism.
chartist
will
attempt
system
must
be:
up
or down,
from
the range
withinbonds,
which
the done
and
if they
do not
up to
with
thediscarded
aid of these
systems
become
confused
markets
of such
things
as atreasury
stock
to
discern
a trendand
by aluminium.
spotting
Mathematically
robust.
Mr Larrymeans
hite, a
price
hascurrencies
previously
been
trading . recognisable with•program
scratch.
trading, which
in america
indexes,
movements
the
price
ofininthese
a common
security
or arbitrage
Mint,
likens
amarket
computer
to its
an
all
analysis
has
the
• partner
broad
inofscope.
a system
that and
worked
between
a futures
it istechnical
hard in
to divine
trends
markets,
commodity
which
confirm
a
“break
out’’,
either
anvil.
ideas
can
be
hammered
out
on
it
belief
that markets
characteristics
during
inflationary
must
also
cashthe
market
(see box1970s
on next
page)
but profitable
when it display
can be done.
Mint, an underlying
up
orare
down,
themanagers
range
which the and in britain
andcapable
discarded
if they do
not
come
upthe
to
that
not
determined
by within
the
fundamental
be
of coming
toin
terms
with
means
dealings
large
blocks
american
firmfrom
of fund
that
specialises
price has previously been trading .
scratch.
all technical analysis has in common the
• broad in scope. a system that worked
belief that markets display characteristics
during the inflationary 1970s must also
that are not determined by the fundamental
be capable of coming to terms with the
W
disinflationary 1980s.
Extrapolating future price movements from
past ones can be tricky. a computer can assist
in calculating the probability of a certain price
disinflationary
1980s.it can judge the
movement
being repeated;
Extrapolating
price movements
Wave
power
probable
risk of future
any investment;
and it from
can
past
bemoney
tricky.should
a computer
can assist
guessones
how can
much
be invested,
and
in
calculating
theinvestment
probability
of a certain
price
are several
ways of forecasting
forthere
how long
that
should
befrom
held,
to
movement
being
repeated;
can judge
the pattern
andrate
movement
ofitprices
where the
achieve
a certain
of return.
probable
of any
it can
financialrisk
markets
willinvestment;
go. the mostand
widely
guess
how
much
money
should
be
invested,
and
used
and
the
oldest
is
chartism.
it
started
Risk averse
for
how long
that investment
should
be
to
winning
disciples
atofthe
beginning
of held,
the not
successful
managers
funds
are rigorous
achieve
certain
rate ofcomputer
return.
century.
Most their
securities
firms theories,
now have but
only
in atesting
a team
plottingthe
share-price
movements
also
in spreading
risk involved.
this means
to averse
predict their
whether
they will go
or
Risk
diversifying
investments
overup several
down. Chartism’s
has
given
it not
successful
managers
of
rigorous
markets.
their
first seniority
aimfunds
is toare
limit
possible
a
respectability
lacking
in
other
forms
of
only
in
testing
their
computer
theories,
but
losses. because of the high level of gearing (the
technical
reason
for
this
is
also
inofspreading
the One
riskcompared
involved.
value
the analysis.
investment
tothis
themeans
down
that markets
in equities,
oninwhich
chartism
diversifying
their
investments
over
several
payment
required)
allowed
futures
markets,
is
most
often
used,
have
existed
for
markets.
their
first
aim
is
to
limit
possible
levels are set at which investments aremuch
sold
and
than
those
in, say,
orgearing
options.(the
losses.
because
of the
highfutures
level of
so longer
losses
stopped.
neither
goes
backtheir
ascompared
far
as thetovarious
value
of funds
the investment
theover
down
Most
spread
investments
at
cycle
theories.
the
most
famous
ofmore.
these
payment
required)
allowed
in
futures
markets,
least ten markets and usually many
this
kondratieff
long tend
wavetoare
theory,
levels
are
set done.
at which
investments
and
is is
notthe
easily
Markets
besold
related
named
af
ter of
thegold
nineteenth
century by
so
losses
(e.g.,
thestopped.
price
is often influenced
Russian
economist
who
first
hit uponofover
it.
Most
funds
spread
their
investments
at
that
of the
dollar).
Even
the
managers
funds
he ascribed
behaviour
of many
prices,
assetthis
least
ten markets
and admit
usually
specialising
in the
futures
that
it is more.
unwise
for
and
warring
societies
to
a futures.
50-60is
not
easily
tend
to
be related
anvalues
investor
todone.
put allMarkets
his
money
into
year
cycle
of
booms
and
busts.
if
true,
the by
(e.g.,
the
price
of
gold
is
often
influenced
a study by the late John Lintner of harvard
next
bustfound
should
occur
at
the
end ofportfolio
that
of the
dollar).
Even
managers
ofthe
funds
University
that
anthe
investment
1980s,
since
the
lastadmit
onewell
wasasin
a and
specialising
in futures
that
it equities
is1929.
unwise
for
that
contained
futures
as
more
up-to-date
version
of
the
“superan
investor
to
put
all
his
money
into
futures.
bonds produced a better return, for the same
cycle
that
by
the
a study
theislate
Lintner and
of harvard
risk,
as theory”
oneby made
up John
ofproduced
equities
bonds
bank Lintner
Credit
analyst,
a Canadian
research
University
found
that an
investment
portfolio
alone.
measured
the risks
involved
it worries
about
the
of funds
a and
that
contained
asofwell
as
equities
in outfit.
investing
in afutures
sample
23 effects
managed
build-up
of liquidity
in
banking
system.
bonds
produced
a better
return,
the same
over
the
three
years
tothe
1982.
to for
measure
the
Wave
heor
ies
of equities
s tockmarke
t
risk,
as one
upa of
and
bonds
historical
risktmade
against
required
rate
of return
movements
aremeasured
based
on similar
principles.
alone.
Lintner
the
risks
involved
(the
risk
reward
ratio),
he calculated
the
the
one
that
has
the widest
following,
in
investing
in aof
sample
of 23 investment
managed
funds
average
return
a particular
and
thethe
Elliott
theory,
is monthly
charted
by
the the
over
years
to 1982.
to measure
divided
itthree
bywave
the
average
deviation
reclusive
Mr.
Robert
Prechter.
he
thinks
historical
risk
against
a
required
rate
of
return
from that return.
that
theinvesting
financial
markets
a five-high
(the
risk
reward in
ratio),
calculated
the
Funds
futureshefollow
have
shown
wave pattern
with
three-wave
correction
average
returnbecause
of a aparticular
investment
returns
partly
bonds and
shares on and
the
period.
Prechter
right,
thetend
Dowdivided
it ifand
byMrthe
average
monthly
deviation
one
hand,
futures
onisthe
other,
to do
Jones
lndustrial
index
reach
3,700
from
that
return. times.
well
at
different
as will
these
markets
allow
before
Vexingly
foralso
hishave
followers,
hehigh
Fundsfalling.
investing
inthey
futures
shown
investors
to
go short,
enable
investors
yet
to work
out
when
will
happen.
returns
partly
because
bonds
and
shares
on the
to has
profit
from
falls
as well
asthis
rises
in
the market.
oneahand,
and
futures
on
the
other,
tend
to do
fund that invests almost exclusively
in
well
at different
times.
these
markets
allow
futures
might
trade
around
30 times
a year
in
of
shares.
Computers,
ofas
course,
have
long
had
to go short,
they
also enable
each
40and
markets.
such investors
churning
ainvestors
role of
in perhaps
securities
commodities
markets.
to
profit
from
falls
wellfive
as rises
inthat
the (thanks
market.
generates
(to
brokers’
delight)
broking
but
it is only
in
theaspast
years
that 20%
invests
almost
in
feesathe
offund
perhaps
of the
totalexclusively
valuepower)
of the
to
advance
in data
processing
futures might trade around 30 times a year in
each of perhaps 40 markets. such churning
generates (to the brokers’ delight) broking
fees of perhaps 20% of the total value of the
Reprinted from the Economist, March 1987
1987
Reprinted from the Economist, March
January
3rd 2015
Finance brief
Finance brief
Reprinted from the Economist, March 1987
Reprinted from the Economist, January 3rd 2015
Computers challenge the stockmarket gurus
Finance brief
Computers challenge the stockmarket gurus
W
hy is Citibank, the world’s most profitable
bank, spending $20m developing what
it calls “expert
computer systems”? Why is
Morgan Guaranty, another big new york bank,
hy isan
Citibank,
the world’s
most profitable
spending
undisclosed
sum (probably
more)
bank,
spending
what
on the
same
arcane $20m
thing? developing
answer: mainly
it
calls
“expert
computer
systems”?
Why
is
because they and other banks like them want to
Morgan
york
develop Guaranty,
computersanother
that willbig
tellnew
them
howbank,
and
spending
an undisclosed
sum (probably
more)
when to deal
in the foreign-exchange
markets.
on
the
same
arcane
thing?
answer:
mainly
their aim is to devise computer-trading systems
because
and the
otherrisk
banks
like theminwant
to
that willthey
reduce
of dealing
lumps
develop
computers
that will
tell them
and
of fast-moving
foreign
exchange
by,how
among
when
deal in
the foreign-exchange
other to
things,
throwing
up buy and sellmarkets.
signals
their aim isthey
to devise
whenever
detectcomputer-trading
a significant shiftsystems
in the
that
willofreduce
the
risk of dealing in lumps
pattern
currency
values.
of Computers
fast-movingcapable
foreign
exchange
by,lightning
among
of match
ing the
other things,
up buy and sell
signals
reactions
of a throwing
top foreign-exchange
dealer,
let
whenever
they detect
a significant
shift in the
the
alone improving
on them,
do not exist-yet.
pattern
of currency
values.
closest things
at the
moment are the systems
Computers
capable
match
ing the lightning
used
increasingly
byofthe
fund-management
reactions
a top foreign-exchange
dealer,
let
firms that of
specialise
in investing in the
futures
alone
improving
on
them,
do
not
exist-yet.
the
markets of such things as treasury bonds, stock
closest things
at the
moment
are the systems
indexes,
currencies
and
aluminium.
used
by trends
the fund-management
it isincreasingly
hard to divine
in these markets,
firms
that specialise
in theMint,
futures
but profitable
when in
it investing
can be done.
an
markets offirm
such
as treasury
bonds,
stock
american
ofthings
fund managers
that
specialises
indexes, currencies and aluminium.
it is hard to divine trends in these markets,
but profitable when it can be done. Mint, an
american firm of fund managers that specialises
W
in computer trading, boasts a cumulative
increase in the value of mutual funds (the
american equivalent of british unit trusts)
under its management in the five years to the
in
boasts
a cumulative
end computer
of 1985 oftrading,
218%. that
compares
with an
increase
in
the
value
of
mutual
funds funds
(the
average increase for the 905 mutual
american
equivalent
of
british
unit
trusts)
measured over the same period of 91.7%.
under
itsfund
management
the five
years similar
to the
true,
managersinhave
achieved
end
of
1985
of
218%.
that
compares
with
an
(and often better) returns with no more
average
increase
for
the
905
mutual
funds
than a pencil and a pad of paper. but few
measured
over theinsame
periodthe
of 91.7%.
have succeeded
reducing
risk of their
true,
fund
managers
have
achieved
similar
investments as well as those funds that
rely
(and
often
better)
returns
with
no
more
on computers to tell them when and what
to
than
a sell.
pencil and a pad of paper. but few
buy and
have
reducing
the 30
risksecurities
of their
in succeeded
the Unitedinstates,
about
investments
as
well
as
those
funds
that
rely
firms managing about $4 billion-worth of other
on
computers
tell them
andlargely
what on
to
people’s
moneytoalready
buy when
and sell
buy
and
sell.
the instructions of a computer trading system.
in the United
states,
about 30
securities
in britain,
the amount
managed
with
the aid
firms
managingisabout
$4 billion-worth
of other
of
computers
much
smaller ($15m),
but
people’s money
already
buy and
sell largely
on
growing.
in neither
country
should
the deals
the
instructions
of
a
computer
trading
system.
done with the aid of these systems be confused
in britain,
the
amountwhich
managed
with the
aid
with
program
trading,
in america
means
of
computers
is
much
smaller
($15m),
but
arbitrage between a futures market and its
growing.
neither
country
should
the page)
deals
underlyingincash
market
(see box
on next
done
the aid
of these
systems
confused
and inwith
britain
means
dealings
in be
large
blocks
with program trading, which in america means
arbitrage between a futures market and its
underlying cash market (see box on next page)
and in britain means dealings in large blocks
Wave power
there are several ways of forecasting from
the pattern and movement of prices where
Wave
power
financial
markets will go. the most widely
used and the oldest is chartism. it started
there
aredisciples
several ways
of beginning
forecastingoffrom
winning
at the
the
the
pattern
andsecurities
movementfirms
of prices
century.
Most
nowwhere
have
financial
marketsshare-price
will go. the most
widely
a team plotting
movements
used
and
the
oldest
is
chartism.
it
started
to predict whether they will go up or
winning
disciples atseniority
the beginning
of the
down. Chartism’s
has given
it
century.
Most securities
have
a respectability
lacking infirms
othernow
forms
of
atechnical
team plotting
share-price
movements
analysis.
One reason
for this is
to
they
will go
up or
thatpredict
marketswhether
in equities,
on which
chartism
down.
hasfor
given
it
is mostChartism’s
often used,seniority
have existed
much
alonger
respectability
lacking
in
other
forms
of
than those in, say, futures or options.
technical
One
forvarious
this is
neitheranalysis.
goes back
as reason
far as the
that markets
in equities,
which chartism
cycle
theories.
the mostonfamous
of these
is
often used, have
much
is most
the kondratieff
longexisted
wave for
theory,
longer than
those
in, nineteenth
say, futures orcentury
options.
named
af ter
the
neither
goes backwho
as far
ashit
theupon
various
Russian
economist
first
it.
cycle
theories.
the
most
famous
of
he ascribed the behaviour of prices, these
asset
is the and
kondratieff
long wave
values
warring societies
to atheory,
50-60named
afof
terbooms
the nineteenth
century
year cycle
and busts. if true,
the
Russian
whoat
first
upon
it.
next busteconomist
should occur
thehit
end
of the
he ascribed
prices,
asset
1980s,
sincethe
thebehaviour
last one of
was
in 1929.
a
values
and warring
societies
to a“super50-60more up-to-date
version
of the
year
of booms
and produced
busts. if true,
the
cyclecycle
theory”
is that
by the
next bust
occur
at the end
of the
bank
Creditshould
analyst,
a Canadian
research
1980s,
since
the last
onethe
waseffects
in 1929.
outfit. it
worries
about
of aa
more
up-to-date
version
of
the
“superbuild-up of liquidity in the banking system.
cycle
theory”
is ies
that of
produced
by thet
Wave
t heor
s tockmarke
bank
Creditare
analyst,
a Canadian
research
movements
based on
similar principles.
outfit.
worries
the effects
of a
the oneit that
has about
the widest
following,
build-up
of wave
liquidity
in theisbanking
the
Elliott
theory,
chartedsystem.
by the
Wave Mr.
t heor
ies Prechter.
of s tockmarke
reclusive
Robert
he thinkst
movements
are
based
on
similar
principles.
that the financial markets follow a fivethe one
thatwith
hasathe
widest following,
wave
pattern
three-wave
correction
the
Elliott
wave
theory,isisright,
charted
the
period.
if Mr
Prechter
thebyDowreclusive
Mr.
Robert
Prechter.
he
thinks
Jones lndustrial index will reach 3,700
that the
financial
markets
a fivebefore
falling.
Vexingly
for hisfollow
followers,
he
wave
pattern
with
three-wave
correction
has yet
to work
outawhen
this will
happen.
period. if Mr Prechter is right, the DowJones lndustrial index will reach 3,700
of before
shares.falling.
Computers,
of for
course,
have long
Vexingly
his followers,
hehad
a role
in
securities
and
commodities
markets.
has yet to work out when this will happen.
but it is only in the past five years that (thanks
to the advance in data processing power)
of shares. Computers, of course, have long had
a role in securities and commodities markets.
but it is only in the past five years that (thanks
to the advance in data processing power)
they have gained ground as a tool of technical economic conditions that underlie them.
analysis. technical analysis of financial markets Chartists look for recognisable patterns that
Computers challenge the stockmarket gurus
starts with the assumption that markets follow suggest the future direction of the price of a
trends determined by previous patterns of price financial instrument. Computers sift historical
they
have gained
ground
as amove
tool randomly.
of technical economic
that
behaviour,
and rarely,
if ever,
data to lookconditions
for repeatable
setsunderlie
of events.them.
Work
analysis.
technical
analysis types
of financial
markets
look
for recognisable
patterns
that
imagine
the different
of traders
in Chartists
out the past
probability
of a sequence
of events,
starts
with market.
the assumption
markets follow
the future
of the
price of ofa
a financial
Each hasthat
a different
set of suggest
and you might
have direction
hit upon the
probability
trends
determined
by previous
of price
instrument. Computers sift historical
expectations
of how
the pricepatterns
will move
and financial
future events.
behaviour,
and
if ever,
move randomly.
look fortrading
repeatable
setstakes
of events.
Work
of how long
torarely,
hold his
investment.
a “local” dataa to
computer
system
a chartist’s
imagine
past
probability
of afinding
sequence
of of
events,
dealing
on the different types of traders in out
workthe
one
step
further. by
a set
rules
a financial
has floor
a different
set of and
you
might
have hit
uponpast
the probability
of
his own market.
accountEach
on the
of a futures
which
can
be tested
against
performance,
expectations
of how
the sell
priceduring
will move
and future
events.to spot a future trend from a
exchange might
buy and
the same
it attempts
of
howa long
to hold his
investment.
“local”
a computeroftrading
a chartist’s
day;
commodities
trader
might athink
of combination
past system
price takes
movements
and
dealing
on
work
one
step
further.
by
finding
a
set
of rules
holding his investment for two or three days; other statistical data that it is fed. if a financial
his ownspeculator
account on
floor two
of aorfutures
can beistested
pastenough,
performance,
a private
for the
perhaps
three which
instrument
held against
for long
there
exchange
might buy
and sell
during
the same
spot probability
a future trend
weeks; a mining
company
hedging
against
the it
is aattempts
certain to
historic
of thefrom
pricea
day;
a
commodities
trader
might
think
of
combination
of
past
price
movements
and
possibility of an ill-timed movement in price, movement repeating itself. the computer issues
holding
hismonths.
investment
two or perceptions
three days; other
statistical
data
thatititspots
is fed.such
if aafinancial
for several
theirfor
different
buy and
sell signals
when
pattern
aaffect
private
for perhaps
twothe
or job
three
long enough,
there
the speculator
market in different
ways.
of instrument
reappearing.isa held
fund for
manager
has merely
to
weeks;
a
mining
company
hedging
against
a certain
historic probability of the price
a technical analyst is to identify a break in the
the is
follow
its commands.
possibility
of start
an ill-timed
in price.
price, movement
itself. profit
the computer
issues
trend and the
of a risemovement
or fall in the
several repeating
ways of spotting
able breakouts
for the
several
months.
different
perceptions
sell signals
spots
such aaverages
pattern
reason
for their
dealing
in futures
- in buy
are and
followed.
somewhen
lookitat
moving
affect
marketundertake
in different
fund manager
merelythat
to
which the
investors
to ways.
buy orthe
selljob
on ofa reappearing.
of prices, and amovements
abovehas
or below
afuture
technical
to gains
identify
a break
in the follow
its Others
commands.
date,analyst
is that isthe
(and
the losses)
average.
measure the momentum of the
trend
and the start
of agreater
rise or fall
in the of
price.
ways
spotting
are potentially
much
because
the fallseveral
or rise in
theofprice
on a profit
chart.able breakouts
the reason
for dealing
futures
- as
in are Mr
followed.
some of
look
at moving
leverage
that these
markets in
allow.
(Often
David harding
adam,
harding averages
& Lueck,
which
investors
undertake
to
buy
or
sell
on
a
of
prices,
and
movements
above
below
that
little as
a
tenth
of
the
value
of
a
futures
contract
a
british
firm
of
fund
managers
specializes
aor cumulative
hy is Citibank, the world’s most profitable in computer trading, boasts that
future
date,
is pledged
that the$20m
gains
(and
the losses)
average.
momentum
of(the
the
needsbank,
to bespending
as
a developing
down-payment).
in futuresOthers
looks
for
rates funds
of change
intrading,
the measure
value
ofthe
mutual
what increase
are
potentially
greatersystems”?
because
of(i.e.,
the
fall
or rise
the price
abritish
chart. his
Futures
marketsmuch
are
usually
very
liquidWhy
in the
pricein
pattern
ofon
a market.
equivalent
of
unitcomputer
trusts)
it calls
“expert
computer
is american
leverage
that these
markets
allow.
(Often
as under
Mr David
harding
of adam,
Lueck,
their
turnover
is high);
andbig
investors
in bank,
them
system
notmanagement
only
generates
buyharding
andyears
sell&signals
its
in the
five
to the
Morgan
Guaranty,
another
new york
little
ashave
a tenth
of
thedelivery
valuesum
of of
a(probably
futures
contract
awhen
british
firm
ofshifts
fund
managers
that
do
not
take
the underlying
priceof
significantly.
it specializes
also
shows
ofthe
1985
218%.
that compares
with
an
spending
an to
undisclosed
more) end
needs
tosame
be pledged
as a down-payment).
in
looks
for
of change
stock,
or commodity.
Futures
howfutures
long increase
antrading,
investment
should
bemutual
held.
for
the
905rates
funds
on thecurrency
arcane
thing?
answer: markets
mainly average
Futures
markets
usually
very
liquid
in the
price
pattern
ofprobability
aperiod
market.
hisa particular
computer
also
enable
to
go short
well want
as(i.e.,
long
a matrix
shows
over
the the
same
of in
91.7%.
because
theyinvestors
and are
other
banks
likeasthem
to measured
their
turnover
high);
and
investors
inown
them
only
generates
buyachieved
and sell
signals
(investors
can issell
stockwill
they
do
nothow
in system
market
offund
any
given
pricehave
movement
occurring
true,not
managers
similar
develop
computers
that
tell
them
and
do
not
to
delivery
theatunderlying
when
pricebetter)
shifts
significantly.
it also
the
hope
of buying
theyof
lack
amarkets.
cheaper (and
over athe
certain
period.
Like awith
contour
map,
often
returns
no shows
more
when
tohave
deal
in take
thewhat
foreign-exchange
stock,
currency
or commodity.
markets than
how
long
anwhat
investment
should
be held.as
price,
thus
making
money
onFutures
the difference
it displays
area (tweely)
a pencil
and
pad
of known
paper.
but“hills
few
their aim
is to
devise
computer-trading
systems
also
investors
go of
short
as well
long have
a matrix
shows
probability
a particular
between
two).the to
of good
ness”.
these
are spots
an
succeeded
inthe
reducing
the inwhere,
risk
of if
their
that enable
will the
reduce
risk
dealing
inaslumps
(investors
can sell
stockexchange
they do not
in investments
market
of any
given
price
movement
investment
isas
held
(usually
for between
two rely
and
well
as those
funds occurring
that
of fast-moving
foreign
by, own
among
the
hope
of buying
whatupthey
a cheaper
over
a certain
Like
a contour
map,
Chart
topper
25 days),
it usually
proves
profitable.
computers
toperiod.
tell
them
when
and what
to
other
things,
throwing
buylack
andatsell
signals on
price,
thusthey
making
onofthe
difference
it displays
are (tweely)
known workable
as “hills
to
understand
what
ismoney
required
theshift
computers
testing
hypotheses
and finding
and sell.what
whenever
detect
a significant
in the buy
between
two). to
good
are
spots is
where,
an
that
areofthe
designed
predict when to buy and of
boundaries
withinthese
which
to about
invest
the
firstifand
in theness”.
United
states,
30
securities
pattern
currency
values.
investment
is
held
(usually
for
between
two
and
sellComputers
in these markets,
look
first
at
traditional
main
task
for
computers
used
by
funds
investing
capable of matching the lightning firms managing about $4 billion-worth of other
Chart
topper
25
days),money
itto
usually
proves
profitable.
methods
ofa top
technical
analysis. the
most
in futures.
be already
successful,
aand
computer
trading
buy
sell largely
on
reactions
of
foreign-exchange
dealer,
let people’s
to
understand
required
of the
computers
testing
and finding
popular
form iswhat
chartism.
ado
chartist
will
attempt
system
musthypotheses
be: of a computer
instructions
tradingworkable
system.
alone
improving
on is
them,
not
exist-yet.
the the
that
arethings
designed
to by
predict
when
to buy
and in
boundaries
within
which robust.
to investMriswith
the first
and
to
discern
a trend
spotting
• Mathematically
Larry
hite,
britain,
the amount
managed
the
aida
closest
at the
moment
are recognisable
the
systems
sell
these in
markets,
look
traditional
main
taskpartner
for computers
bya funds
investing
movements
thebyprice
of
aatsecurity
or of
Mint, used
likens
computer
tobut
an
computers
isof much
smaller
($15m),
usedinincreasingly
the first
fund-management
methods
ofwhich
technical
analysis.
thefutures
most growing.
in futures.
be
successful,
a should
computer
trading
commodity
confirm
a “breakinout’’,
either
anvil.
ideas
can
be hammered
out
on it
intoneither
country
the
deals
firms that specialise
in investing
the
popular
form
is chartism.
chartist
will
attempt
system
must
be:
up
or down,
from
the range
withinbonds,
which
the done
and
if they
do not
up to
with
thediscarded
aid of these
systems
become
confused
markets
of such
things
as atreasury
stock
to
discern
a trendand
by aluminium.
spotting
Mathematically
robust.
Mr Larrymeans
hite, a
price
hascurrencies
previously
been
trading . recognisable with•program
scratch.
trading, which
in america
indexes,
movements
the
price
ofininthese
a common
security
or arbitrage
Mint,
likens
amarket
computer
to its
an
all
analysis
has
the
• partner
broad
inofscope.
a system
that and
worked
between
a futures
it istechnical
hard in
to divine
trends
markets,
commodity
which
confirm
a
“break
out’’,
either
anvil.
ideas
can
be
hammered
out
on
it
belief
that markets
characteristics
during
inflationary
must
also
cashthe
market
(see box1970s
on next
page)
but profitable
when it display
can be done.
Mint, an underlying
up
orare
down,
themanagers
range
which the and in britain
andcapable
discarded
if they do
not
come
upthe
to
that
not
determined
by within
the
fundamental
be
of coming
toin
terms
with
means
dealings
large
blocks
american
firmfrom
of fund
that
specialises
price has previously been trading .
scratch.
all technical analysis has in common the
• broad in scope. a system that worked
belief that markets display characteristics
during the inflationary 1970s must also
that are not determined by the fundamental
be capable of coming to terms with the
W
disinflationary 1980s.
Extrapolating future price movements from
past ones can be tricky. a computer can assist
in calculating the probability of a certain price
disinflationary
1980s.it can judge the
movement
being repeated;
Extrapolating
price movements
Wave
power
probable
risk of future
any investment;
and it from
can
past
bemoney
tricky.should
a computer
can assist
guessones
how can
much
be invested,
and
in
calculating
theinvestment
probability
of a certain
price
are several
ways of forecasting
forthere
how long
that
should
befrom
held,
to
movement
being
repeated;
can judge
the pattern
andrate
movement
ofitprices
where the
achieve
a certain
of return.
probable
of any
it can
financialrisk
markets
willinvestment;
go. the mostand
widely
guess
how
much
money
should
be
invested,
and
used
and
the
oldest
is
chartism.
it
started
Risk averse
for
how long
that investment
should
be
to
winning
disciples
atofthe
beginning
of held,
the not
successful
managers
funds
are rigorous
achieve
certain
rate ofcomputer
return.
century.
Most their
securities
firms theories,
now have but
only
in atesting
a team
plottingthe
share-price
movements
also
in spreading
risk involved.
this means
to averse
predict their
whether
they will go
or
Risk
diversifying
investments
overup several
down. Chartism’s
has
given
it not
successful
managers
of
rigorous
markets.
their
first seniority
aimfunds
is toare
limit
possible
a
respectability
lacking
in
other
forms
of
only
in
testing
their
computer
theories,
but
losses. because of the high level of gearing (the
technical
reason
for
this
is
also
inofspreading
the One
riskcompared
involved.
value
the analysis.
investment
tothis
themeans
down
that markets
in equities,
oninwhich
chartism
diversifying
their
investments
over
several
payment
required)
allowed
futures
markets,
is
most
often
used,
have
existed
for
markets.
their
first
aim
is
to
limit
possible
levels are set at which investments aremuch
sold
and
than
those
in, say,
orgearing
options.(the
losses.
because
of the
highfutures
level of
so longer
losses
stopped.
neither
goes
backtheir
ascompared
far
as thetovarious
value
of funds
the investment
theover
down
Most
spread
investments
at
cycle
theories.
the
most
famous
ofmore.
these
payment
required)
allowed
in
futures
markets,
least ten markets and usually many
this
kondratieff
long tend
wavetoare
theory,
levels
are
set done.
at which
investments
and
is is
notthe
easily
Markets
besold
related
named
af
ter of
thegold
nineteenth
century by
so
losses
(e.g.,
thestopped.
price
is often influenced
Russian
economist
who
first
hit uponofover
it.
Most
funds
spread
their
investments
at
that
of the
dollar).
Even
the
managers
funds
he ascribed
behaviour
of many
prices,
assetthis
least
ten markets
and admit
usually
specialising
in the
futures
that
it is more.
unwise
for
and
warring
societies
to
a futures.
50-60is
not
easily
tend
to
be related
anvalues
investor
todone.
put allMarkets
his
money
into
year
cycle
of
booms
and
busts.
if
true,
the by
(e.g.,
the
price
of
gold
is
often
influenced
a study by the late John Lintner of harvard
next
bustfound
should
occur
at
the
end ofportfolio
that
of the
dollar).
Even
managers
ofthe
funds
University
that
anthe
investment
1980s,
since
the
lastadmit
onewell
wasasin
a and
specialising
in futures
that
it equities
is1929.
unwise
for
that
contained
futures
as
more
up-to-date
version
of
the
“superan
investor
to
put
all
his
money
into
futures.
bonds produced a better return, for the same
cycle
that
by
the
a study
theislate
Lintner and
of harvard
risk,
as theory”
oneby made
up John
ofproduced
equities
bonds
bank Lintner
Credit
analyst,
a Canadian
research
University
found
that an
investment
portfolio
alone.
measured
the risks
involved
it worries
about
the
of funds
a and
that
contained
asofwell
as
equities
in outfit.
investing
in afutures
sample
23 effects
managed
build-up
of liquidity
in
banking
system.
bonds
produced
a better
return,
the same
over
the
three
years
tothe
1982.
to for
measure
the
Wave
heor
ies
of equities
s tockmarke
t
risk,
as one
upa of
and
bonds
historical
risktmade
against
required
rate
of return
movements
aremeasured
based
on similar
principles.
alone.
Lintner
the
risks
involved
(the
risk
reward
ratio),
he calculated
the
the
one
that
has
the widest
following,
in
investing
in aof
sample
of 23 investment
managed
funds
average
return
a particular
and
thethe
Elliott
theory,
is monthly
charted
by
the the
over
years
to 1982.
to measure
divided
itthree
bywave
the
average
deviation
reclusive
Mr.
Robert
Prechter.
he
thinks
historical
risk
against
a
required
rate
of
return
from that return.
that
theinvesting
financial
markets
a five-high
(the
risk
reward in
ratio),
calculated
the
Funds
futureshefollow
have
shown
wave pattern
with
three-wave
correction
average
returnbecause
of a aparticular
investment
returns
partly
bonds and
shares on and
the
period.
Prechter
right,
thetend
Dowdivided
it ifand
byMrthe
average
monthly
deviation
one
hand,
futures
onisthe
other,
to do
Jones
lndustrial
index
reach
3,700
from
that
return. times.
well
at
different
as will
these
markets
allow
before
Vexingly
foralso
hishave
followers,
hehigh
Fundsfalling.
investing
inthey
futures
shown
investors
to
go short,
enable
investors
yet
to work
out
when
will
happen.
returns
partly
because
bonds
and
shares
on the
to has
profit
from
falls
as well
asthis
rises
in
the market.
oneahand,
and
futures
on
the
other,
tend
to do
fund that invests almost exclusively
in
well
at different
times.
these
markets
allow
futures
might
trade
around
30 times
a year
in
of
shares.
Computers,
ofas
course,
have
long
had
to go short,
they
also enable
each
40and
markets.
such investors
churning
ainvestors
role of
in perhaps
securities
commodities
markets.
to
profit
from
falls
wellfive
as rises
inthat
the (thanks
market.
generates
(to
brokers’
delight)
broking
but
it is only
in
theaspast
years
that 20%
invests
almost
in
feesathe
offund
perhaps
of the
totalexclusively
valuepower)
of the
to
advance
in data
processing
futures might trade around 30 times a year in
each of perhaps 40 markets. such churning
generates (to the brokers’ delight) broking
fees of perhaps 20% of the total value of the
Reprintedfrom
fromthe
theEconomist,
Economist,January
March 1987
Reprinted
3rd 2015
Finance brief
they have gained ground as a tool of technical economic conditions that underlie them.
analysis.
technical
analysis ofthe
financial
markets Chartists
Computers
challenge
stockmarket
gurus look for recognisable patterns that
starts with the assumption that markets follow suggest the future direction of the price of a
trends determined by previous patterns of price financial instrument. Computers sift historical
Reprinted
the Economist,
2015 sets of events. Work
behaviour, and rarely, if ever,
move from
randomly.
data toJanuary
look for 3rd
repeatable
imagine the different types of traders in out the past probability of a sequence of events,
a financial market. Each has a different set of and you might have hit upon the probability of
expectations of how the price will move and future events.
of how long to hold his investment. a “local”
a computer trading system takes a chartist’s
Plugged
dealing
on in
work one step further. by finding a set of rules
his own account on the floor of a futures which can be tested against past performance,
Program trading used to mean buying and selling large baskets of stock as if they were
exchange
might
buy and
during refers
the same
it attempts
to spot
future trend
from a
individual
shares.
now,sell
it usually
to arbitrage
between,
say, aa stock-index
futures
day;contract
a commodities
trader and
might
combination
pastonprice
movements
traded in Chicago
thethink
sharesofof 500
companiesof
listed
the new
york stockand
Exchange
that underlie
holding
his investment
forit.two or three days; other statistical data that it is fed. if a financial
suppose
that an
investor
has a batch
of shares
worthfor
$10m.
could hold
a private
speculator
forindividual
perhaps two
or three
instrument
is held
longheenough,
there
on to them and pocket the dividends paid on them. Or he could sell the shares, invest the
weeks; a mining company hedging against the is a certain historic probability of the price
money instead in treasury bonds, and buy them back in three months’ time. assuming that
possibility
of an
ill-timed
movement
price,
repeating
itself.
the computer
issues
the interest
received
from
investingin
the
moneymovement
in the meantime
in the
money
markets was
for greater
severalthan
months.
their different
perceptions
buy and
signals
when
it spotsthe
such
a pattern
the dividends
to be gained
from owning
the sell
same
amount
of shares,
investor
could
better in
offdifferent
at the endways.
of three
as the commodity
put it,
would to
affect
thebemarket
themonths.
job of Or,
reappearing.
a funddealers
manager
hashemerely
have saved
himself
theidentify
“cost ofacarry”.
a technical
analyst
is to
break in the follow its commands.
the opposite of this is the kind of program trade which causes problems at the “triple
trend
and the start of a rise or fall in the price.
several ways of spotting profit able breakouts
witching hour”. that is when (as happened on March 20th) contracts on stock-index futures, on
the
reason
for
dealing
in
futures
in
are
followed.
some
look them
at moving
averages
stock-index options and on the options of the individual
shares that
underlie
expire at
the
which
investors
same
time. undertake to buy or sell on a of prices, and movements above or below that
a program
trader
willthe
buylosses)
shares which
make
up themeasure
index, either
by buying of
all the
future typically,
date, is that
the gains
(and
average.
Others
the momentum
shares in itmuch
or-more
likelybecause
because of
follows
these shares
arethe
potentially
greater
of the
thecost-a
fall selection
or rise in that
the price
onthem.
a chart.
are then sold to fulfil the seller’s obligations when the futures contract that represents them
leverage
that these markets allow. (Often as
Mr David harding of adam, harding & Lueck,
expires. With luck, the premium over the market price of the futures contract will more than
computer
boaststhat
a specializes
cumulative
little
as
tenth
of
of
futures
contract ainbritish
firm oftrading,
fund managers
hyais
Citibank,
the
world’s
most profitable
compensate
forthe
thevalue
cost
of a
carry.
ato
computer
must monitor
the prices of
the futures
contracts
those
the
underlying
increase
intrading,
theand
value
ofof
mutual
funds
(the
needs bank,
bespending
pledged
as a developing
down-payment).
in
futures
looks
for
rates
of change
$20m
what
it must
calculate
the liquid
cost of
carry,
work
out
whether
the two
prices
american
equivalent
british
unit
trusts)
Futures
arecomputer
usually
very
(i.e.,
in
the
price
pattern
oforaofnot
market.
his
computer
it securities.
calls markets
“expert
systems”?
Why
is and
are out of line. that done, it must help the trader decide on the cheapest way of executing
under its
in the
to the
their
turnover
is high);
andbig
investors
in them
notmanagement
only generates
buy five
and years
sell signals
Morgan
Guaranty,
another
new york
bank, system
the course it recommends.
end
of
1985
of
218%.
that
compares
with
do
notProgram
have
take
delivery
of
the
underlying
when
the
price
shifts
significantly.
it
also
shows
spending
antoundisclosed
sum
(probably
more)
trading is carried our mostly by investment banks for their big institutional an
average
increase
for the
funds
stock,
currency
commodity.
Futures
markets
long
an
investment
should
bemutual
held.
onclients.
the
same
arcane
thing?
answer:
mainly
Profitor
margins
on such
trades
used to how
be
as
much
as 3% above
the905
cost
of carry.
they
are
now
down
togo
0.5%.
this
is
mainly
because
increase
in program
trading
in
recent
over
the
same
period
ofin91.7%.
also
enable
investors
to
short
asthem
well
as
long
athe
matrix
shows
the
probability
a particular
because
they
and
other
banks
like
want
to measured
years has
caused
markets
to
moreand
efficient.
if of
traders
switched
their
extensive
true,
fund
managers
have
achieved
similar
(investors
can
sell stock
they
dothem
not how
own
in
market
any given
priceoff
movement
occurring
develop
computers
that
will
tellbecome
hardware, the markets would become slack again, and the opportunities for making money
(and a often
no map,
more
the
hope
of buying
they lack at a markets.
cheaper over
when
to deal
in thewhat
foreign-exchange
certainbetter)
period.returns
Like a with
contour
in them would increase.
a pencil
pad of known
paper. as
but“hills
few
price,
thusis making
on the difference
their aim
to devisemoney
computer-trading
systems itthan
displays
whatand
are a(tweely)
have
succeeded
in reducing
the where,
risk of iftheir
that
will
reduce
the
risk
of
dealing
in
lumps
between
the
two).
of
good
ness”.
these
are
spots
an
money invested a year. to that must be added their success is achieved largely because the
investments
as well
those
funds
that
rely
of fast-moving
exchange
among gains
investment
is held
(usually
for
between
twomore
and
management
feesforeign
of around
6%. soby,
a futures
from spotting
a as
good
trend
usually
ondays),
computers
tell
them
when
and markets
what to
otherusually
things, needs
throwing
buyaand
sell signals
Chart
topper
25
it usually
proves
profitable.
fund
to up
show
return
on its than
offset
thetolosses
incurred
when
investment
of at
least
25%
a year
to break
even.
sideways.
it is alsoand
because
buytesting
and
sell.
whenever
they
detect
a significant
shift
in
the drift
to
understand
what
is required
of the
computers
hypotheses
findingdisinflation
workable
Most
do.
Critics
say
thiswhen
is because
the has
allowed
investors
to
make ismoney
in
the within
United
states,
about
30
pattern
currency
that
are of
designed
tovalues.
predict
to buy and
boundaries
which
to invest
thesecurities
firstfrom
and
fad for computer trading has emerged during falling commodity prices. Mr harding reckons
firms
managing
about
$4
billion-worth
of other
Computers
capable
of
match
ing
the
lightning
sell
in these markets, look first at traditional main task for computers used by funds investing
the greatest bull market since the roaring that, although only 50% of system trades are
people’s
already
sell
largely
on
reactions supporters
top foreign-exchange
dealer,
let profitable,
methods
of a technical
analysis.
the
most
in
futures.money
to
be successful,
aand
computer
trading
twenties.
of the
funds retort
that
these
are onbuy
average
three
times
the instructions
alone improving
on them,
do not exist-yet.
the system
popular
form is chartism.
a chartist
will attempt
must be: of a computer trading system.
britain,
the amountrobust.
managed
with the
closest
things
at thebymoment
arerecognisable
the systems in •
to
discern
a trend
spotting
Mathematically
Mr Larry
hite,aid
a
muchlikens
smaller
($15m),to but
used increasingly
the offund-management
movements
in the byprice
a security or of computers
partner is
of Mint,
a computer
an
in neither
country
should the
firms that specialise
in investing
the futures
commodity
which confirm
a “breakinout’’,
either growing.anvil.
ideas can
be hammered
out deals
on it
aid of these
systems
confused
markets
of such
as treasury
up
or down,
fromthings
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© the Economist newspaper Limited, London (1987)
if Mrfutures
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of shares.
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of the
PLUS ÇA CHANGE,
PLUS C’EST LA
MÊME CHOSE
By David Harding, May 2015
“...THE ESSENCE OF TREND FOLLOWING
HAS BEEN EFFECTIVE BEYOND MY WILDEST
DREAMS AND, FOR ME IT HAS BEEN MORE
The Economist Article from March 1987 was at least partly
stimulated by my acquaintanceship with a journalist at the
magazine; a friend of a friend from college who was able
to leverage a substantial piece of financial journalism off the
fledgling Adam, Harding & Lueck. I am certain that he and I
would never have thought for one moment that that company
would still be thriving 27 years later having grown to more
than 2000 times the size! (To say nothing of the existence of
the much larger Winton and other ‘spawn’ of AHL.)
The approach described in the article to running computer
trading systems is essentially the same today as it was then
(indeed the chart of £/$ illustrating the article is the same chart
exactly as the opening chart in my presentation today). It has
truly withstood the test of time. However, the journalist wasn’t
exaggerating when he said that the futures fund of the time
had to make at least 25% to break even, and that probably
didn’t even take full account of what we now call slippage – the
amount we move the market getting into and out of trades.
Ironic then, that while trend following systems were producing
such exorbitant gross profits, financial market academics
were fleshing out the theory of why such profits would be
theoretically impossible to achieve. Masked by the high fees
and costs and by the inherent improbability that technical
analysis and systematic trend-following should be of any
profound importance, the world sailed on its growing acceptance
of ‘efficient markets’, untroubled by the reproach offered by the
continued success of such systems.
The warning offered by the journalist, that such systems were
liable to be self- defeating, proved to be much, much too soon.
It was a reasonable voice of caution and scepticism but it proved
misleading, as have its many echoes down the years. There
is further irony in the fact that the main anxiety prospective
investors have about the methodology remains unchanged
over such a long period. Perhaps the sceptic’s warnings of too
much money following the same strategy will have force one
day, but they have been persistently wrong so far. Indeed one
RISKY TO DIVERSIFY AWAY FROM IT...”
might wonder why they consistently see systematic traders as
more likely to act homogeneously than human ones where the
evidence of crowd behaviour is much more tangible.
Anxious myself about this undeniable and credible argument
I have been constantly motivated to research and discover
new approaches to trading and investing over the intervening
years and the computer aided method of analysis has proven
its worth. However, the essence of trend following has been
effective beyond my wildest dreams and, for me it has
been more risky to diversify away from it than to embrace it
wholeheartedly. In my career I have remained loyal enough to
it to have benefited mightily from its sustainability, albeit having
steadily ratcheted down the aggressiveness of the trading in
terms of both trading activity and leverage. As the years have
unfolded and I have had experience of the seemingly magical
phenomenon of trends, my prejudice in favour of this unloved
and unheralded investment approach has hardened. To a
statistician this is called a Bayesian Philosophy. You start with
your prejudices and modify them in the light of experience.
I started with a weak belief in trend following because
conventional opinion said it couldn’t work. As I saw it work
year after year my belief in it has hardened and I have sought
explanations as to why the conventional orthodoxy was wrong.
Over the years, it is the orthodoxy that has gradually come
to seem ridiculous; that market movements can be perfectly
described by the heat diffusion equation from physics, that
the movements of market prices are analogous to the buffeting
of smoke particles by the invisible atoms in a gas (Brownian
Motion). How much more credible does it seem that the
movements of markets should be the subject of a somewhat
arcane social science which uses modern computational
techniques to build and evaluate models in a simulated
parallel reality?
How fortunate for me therefore, that driven by a mixture of
entrepreneurial drive, greed, curiosity and desperation I have been
able to build companies by exploiting this philosophical
misunderstanding of modern markets. My success has been founded
on the globalisation of financial markets and the information
technology revolution. From small acorns, mighty oaks grow!