Picking stocks? You’re up against banks and hedge funds

When you think about who does really well buying and selling shares, on a global scale, you’re probably not thinking about ‘mum and dad’ investors, day traders and Gen Z. You’re more likely thinking about big institutions; fund managers, investment banks and hedge funds.

Sometimes we mere mortals can benefit from their winning ways, like when they manage our super funds, but often we don’t: like when their fees eat up our modest returns, or when they ‘short’ a company we love… Occasionally their methods backfire very publicly – as in the GameStop case.

Everyday investors attempting to pick stocks and build their own share portfolios often lose out when going up against institutions. US research showed that they generally underperform the S&P500 by 42%! That being the case, their money would be much better off just sitting in an exchange-traded fund (ETF) tracking that index. They may not ‘win big’ but at least they won’t be left so far behind. 

ETFs: a step in the right direction for everyday investors

ETFs have definitely entered the mainstream over the last couple of years, with a growing range of robo-advisor apps making them more accessible and user-friendly than ever. Aussie brands like Raiz, Stockspot and CommSec Pocket are helping popularise – some would say democratise – ETFs in a significant way. A report from the ASX last year showed that 20% of Australian investors already hold ETFs. This is great to see.

But if it’s more than stability you crave, ETFs and ‘passive investing’ generally aren’t the secret to unlocking hedge fund-like returns. The ‘secret’ is another form of systematic investing: algorithmic or algo trading. 

Algo trading is yet to make its way into everyday conversations in the same way. There’s still no household name offering ‘hedge fund like’ algo trading for retail investors. That doesn’t mean algorithms aren’t commonly used – quite the opposite. Some estimates put the proportion of algo trades at 70-80% of all trades in US stocks! We’ll look at what that means below, but just to reiterate: the vast majority of all share trading is already done by machines running algorithms rather than people making decisions. And it’s currently the major institutions driving this. 

The next frontier: algorithmic trading for retail investors

While most ETFs are designed to track the market they belong to, investment algorithms are normally designed with the objective of outperforming, i.e. beating the market while managing risk.

When we say algorithms are the secret, we mean that big institutions routinely use technology to do things humans simply cannot.

Essentially, an algorithm can be written to do whatever you want it to. It can buy or sell any share (including ETFs) automatically when certain events happen, or don’t happen. Using machine learning, algorithms can also ‘learn’ and change over time, working within set constraints and objectives that you provide.

Algorithms can: remain always ‘on’, execute multiple trades in different markets instantaneously – 24/7, make purely rational decisions, consistently follow their own rules (or develop new ones), process far more data in real-time than we can even imagine, and even predict events before they happen based on time-tested ‘signals’ of economic growth or doom…

Unlike humans, they’re never: asleep, tired, hungry, emotional, overconfident, ‘burnt’ by past experience, superstitious, overwhelmed by the amount of available data, acting on instinct or ‘gut feel’, taking tips from friends and pundits, too attached to any particular stock or chasing their losses.

They’re also never off to work, playing with the kids, crashing in front of the TV and even enjoying a quiet drink. Life is busy and these things matter… but, when combined, they have been costing people dearly on the investing front!

The strict discipline, deep insight and surprising foresight of well-built algorithms are the key to potentially massive returns.

Unhedged is coming in 2021

We’re on track to launch a next-generation robo-advisor app bringing algorithmic trading to the retail market in Australia.

We’ve been investing large amounts of our own money and running backtests (trial runs of our algorithms using real historical data) with different algorithms for years now and tracking our returns. The same algorithms you’ll be able to put to work for you through our upcoming app. 

The results have been extraordinary. For one example, in a 13-year backtest that covered both the GFC and the pandemic, one of our algorithms generated a 900% return!

Stay tuned for our next post to see some of the other results…

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