With the rise of the digital era, many investors believe they can make investment decisions using charts and algorithmic trading to help improve their investment performance.
Technical analysis is the name given to making investment decisions based on market activity, like past volume totals or prices. It often uses charts as a way to try and help clarify when to make buy or sell decisions. You hear interesting terms thrown about by technicians, phrases like the double handle, flying death cross, 200-day moving average, 50-day moving average, higher highs, lower lows, or just maybe, the ever-popular triple humpback bottom — as opposed to the double bottom or just a nice-looking bottom.
Another area that has become popular is algorithmic trading, which is using computer-based programs to make investing or trading decisions. Algorithmic trading is based on mathematical formulas that weight different variables of the formula according to how much emphasis the variable should make up of the investment decision.
In most institutional cases, the basis for using algorithms is to bring trading costs down by automating trading decisions, more commonly known as high-frequency trading. Algorithms are also used by institutions to help identify potential arbitrage situations in asset classes, such as equities, bonds, currencies, interest rates instruments or in merger arbitrage.
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Interestingly enough, high-frequency trading volumes as a percentage of total volume of trades have been trending down. In 2009, HFT trading accounted for 61 percent of all U.S. equity trades and 38 percent of all European trades. In 2013, those figures dwindled to 49 percent in the U.S. and 25 percent in Europe. The high-profile incident of the flash crash in 2010 and the 2012 problems of then-HFT king Knight Trading have further called into question the value of HFT platforms. Just recently, IEX Group set up a new exchange with a speed bump as an alternative to HFT platforms used by other large exchanges.
In any event, for individual investors the digital tools like charts and algorithms can potentially be useful if applied in conjunction with solid analysis of any business you are considering for an investment. Looking at the strength and history of the management, competitive positioning of the business, balance sheet situation, five years of operating results and future growth potential are fundamentals that can be enhanced by charts, which show past stock performance and trading volumes.
Algorithms might be useful in making your trades more efficient, especially if you are placing large-dollar trades. Still, if you sense skepticism about using the new digital tools as your only method to make investment decisions, you are correct, as services are similar to fortune tellers or palm readers.
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Consider the history of the investment industry and some well-known investors that made their fortunes and those who owned shares in their entities who are quite well off. Ben Graham, Warren Buffett, Sir John Templeton, Michael Price, Charlie Munger, and more recently, activists like Bill Ackman, David Einhorn, or even Carl Icahn all are fundamental investors who put a great deal of work into understanding, evaluating and then investing based on business fundamentals. Their investment styles may be different based on value or growth as an emphasis, but analyzing potential opportunities is the common underlying theme.
The best way to build wealth is through good, old-fashioned fundamental business analysis and by making well-informed decisions to invest in the best businesses one can find at the most attractive price one can.
Develop a routine, a method, or a process you build as a way to systematically think about evaluating potential investments. First, pick three to five businesses you are familiar with and feel like there will be opportunity for the business to grow for a long period of time. Second, read the most recent 10-Q filing the company made with the Securities and Exchange Commission to become familiar with the management, operational performance, business quality, competitive landscape and financials.
Third, consider visiting a few locations (if they are retail based) to get a sense of how the business functions on the ground. Fourth, if possible, contact competitors or analysts to get their point of view about the industry. Fifth, compare the valuations of your opportunity versus the others to see how it stacks up.
[Read: Should a Part-Time Job Be Part of a Retirement Plan?]
You will notice none of these steps involve the double bottom, death cross or a moving average. Still, these new technological tools are here and it makes a great deal of sense to apply them in ways which can be useful.
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A New Age of Investing? Nope, But Digital Tools Can Help You. originally appeared on usnews.com
