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Artificial Intelligence vs Trend Following Trading

Business 2.0 featured an article by Carla Fried that raised the argument of artificial intelligence as a potential investment tool. Many of the points and analogies presented in the article actually assist in explaining trend following’s success. Here are excerpts from the article with our commentary:

If ever there were a field in which machine intelligence seemed destined to replace human brainpower, the stock market would have to be it. Investing is the ultimate numbers game, after all, and when it comes to crunching numbers, silicon beats gray matter every time. Nevertheless, the world has yet to see anything like a Wall Street version of Deep Blue, the artificially intelligent machine that defeated chess grand master Gary Kasparov in 1997. Far from it, in fact: When artificial-intelligence-enhanced investment funds made their debut a decade or so ago, they generated plenty of media fanfare but only uneven results. Today those early adopters of AI, like Fidelity Investments and Batterymarch Financial, refuse to even talk about the technology…Data flows in not just from standard databases but from everywhere: CNN, hallway conversations, trips to the drugstore. “Unless you can put an emotional value on certain events and actions, you can’t get the job done.” Naturally, investors don’t process this hodgepodge of inputs according to some set of explicit, easily transcribed rules. Instead, the mind matches the jumble against other jumbles stored in memory and looks for patterns, usually quite unconsciously. “Often, great investors can’t articulate the nature of their talent. They’re like pool players who make incredible trick shots on intuition.” Fine for them, but how do you code that?

TurtleTrader® comment: Coding emotions? Measuring value? Why not go right to the market price to measure value like trend followers do everyday? Why make the problem more complicated than need be?

Andre Archambault, for example, manages Standard & Poor’s Neural Fair Value 20, an AI-enhanced model portfolio open to subscribers of S&P’s Outlook newsletter. His AI software analyzes the 18 financial variables that he uses to calculate fair values for his universe of 3,000 stocks…

TurtleTrader® comment: Instead of using 18 variables to arrive at fair value, why not accept the one variable (the market price) that actually is the fair value? No calculation needed!

History shows that [problems] eventually strike every quantitative investment approach, from blunt rules of thumb like the “dogs of the Dow” (buy the 10 highest-yielding Dow stocks each year) to the arcane strategies cooked up by Ph.D.s at hedge fund D.E. Shaw Group. The reasons are endless: Financial conditions can change; other investors can catch on, eliminating a winner’s edge; or tastes can shift, and what excited the market.

TurtleTrader® comment: If you are trying to foresee “anything” — no strategy will work. If you are trying to predict tomorrow — that will be a bust too. Arcane trading strategies? Stop. Will not work. Using a computer to tell you about tomorrow? A sure fire plan to lose money. From this moment forward when reading any financial press keep track of the prediction mentality that seems so pervasive. Does anyone in the mainstream EVER acknowledge that the very notion of prediction is a false idol?

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