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How to Beat the Machines Before They Beat You

Algorithms and trading “machines” are everywhere. Indeed, I have to confess that I have created and managed several investment programs that are almost purely algorithmic, so I feel like I am betraying the confidence of the cult of systematic traders when I write a column on how to tackle the machines. But having recently watched the first few of the Terminator movies (again) where machines run amuck and try to terminate the humans that created them, I thought maybe us human investors need a helping hand to even the odds a bit.

So let’s get to it. Basically there are three ways to deal with the machines.

First, you can simply give up and hide, go underground, and wait until the machines have devoured each other.

Second, you can build a better machine. This requires skill, resources and time.

Third, you can try to anticipate what the machines are going to do, and beat them to it.

I cannot opine on the first option, though it is true that many old school investors have thrown in the towel and are likely waiting to pounce as soon as the barriers to entry to algorithmic warfare become more surmountable. If you are a professional, your investors may not allow you to wait, however.

Regarding the second option, there is clearly a mad dash by a number of large, old-school investors to now invest heavily in technology and algorithmic trading, but it remains to be seen whether the newcomers can catch up and maybe even exceed the ability of the incumbents.

So, we will focus on the third option to counter and possibly beat the machines – to understand and anticipate what they are most likely to do, and get there first in a way that favors us, not the machines.

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