Algos v/s Humans

Algos v/s Humans

When I began writing this article about Human vs Algos in Trading little did I think what I was getting into. The world of Trading is worried! Trades are being taken over by AI, HFT etc OR is it?!

Lexicon First

We hear all these terms below used interchangeably, but they differ in concept – “Algos” ……. “Trading machines” …. “High-frequency trading”….“Black-box trading”.

But broadly they may be grouped into two. One is Algorithmic Trading, where Humans make Trading decisions and computers execute them, and second is Trade Origination, where Computers make both Trading decision and execute them. While the later is rare, recent developments in AI has rekindled some interest in it.

Is the Price Fair? – Traders gut

Good news for us Humans…

Researchers from the universities of Cambridge and Sussex in England and Australia’s Queensland University of Technology found that the best traders are aware of their bodies’ signals, even if unconsciously, and use them to make more money.

The team of neuroscientists compared the interoceptive sense—an indicator of their self-awareness—of 18 London hedge fund traders working under high pressure with that of students in a control group. All were asked to assess their own heart rates in beats per minute at different points in the day under various conditions. Traders performed significantly better than the control group and were much more aware of their heart rates: The mean score for traders was 78.2, compared to 66.9 for the control group.

Among those traders, those with the strongest interoceptive sense were also more successful in their jobs. In other words, traders who read their bodies’ messages and acted accordingly, whether they were conscious of it, made more profitable trading decisions over the course of a year.

“Human traders may have the instincts and intuition to add statistically significant value, because the best ones do an excellent job of picking price levels and sourcing liquidity,” adds Dave Weisberger, the head of equities at strategic advisory firm Viable Markets and the president of boutique consultancy Exquam who also worked at Two Sigma, Citi, Salomon Smith Barney and Morgan Stanley.

“Good traders have the intuition to say, ‘The price has gone down too much, I want to stand firm, I don’t want to trade here – particularly in this sort of market where it’s not moving too much, that’s relevant,” he says. “Also, you need a human trader for negotiating a block trade – on the sell-side, you need sales-traders who have lots of experience and know who they can call that won’t leak information when looking for a counter-party on the other side of the trade.”

Market is going up or Down…Or just stay Sideways!

Traders love Volatility and most of the Automated systems are designed to en-cash upon that. However if the volumes drop and the market keeps moving sideways with no direction, the Algos most of the time fails to detect. Here the Humans exhibit an edge.

 “Sideways or calm markets can be a challenge for the machine-learning trend-following algorithm – primarily because it needs a number of steps to recognize that it may be in a sideways market and how it will trade that environment.” says Daniel Gramza, the founder and president of Gramza Capital Management and DMG Advisors and a trading coach to brokerages, banks and hedge funds.

“The trader can assess what is the typical magnitude of a sideways move, how long it typically last, is there a particular time of day, week or month when sideways moves occur and how does it typically break out of the sideways move,” Gramza says. “Although these parameters are simple to assess for the trader, it can be challenging for the machine-learning algorithms,” he says.

Which Camp am I in?

While the Human in me, biases me to say –“We are here to stay and Algos are no match”, I do cognize the fact that as I write this, self-learning programs are being written which are much faster in making decisions and executing the decisions.

Going forward I also do believe that machine would continue to OUT run me on the exchange trades, extracting small values out of arbitrage inefficiencies in pricing, which my human eye would fail to detect.

But market trades by EMOTIONS. People get tired buying and they sell and when they get tired of selling they buy. That’s how trends are formed, and the basic concept of Technical Trading and Fibonacci Nos is based on the fact that, market are formed by these emotional / intuitional gyrations.

Markets are formed with Traders taking two Sides – Bears and Bulls, in spite of the fact that data / information provided to the traders are the same. And it’s always not just logical, why a trader would take a side. Its biased-on ego, greed, confidence, experience, market information, which would only come out after a few beers or may be a family function.

Lets call our Algo just a friend in need for trading for now..Shall we? He is a Fast executer, has a good eye and is sharp. But will he replace me?? Well I am the Boss.

Debmalya Roy
Lead – Derivatives
Swiss Singapore Overseas Enterprises

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