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I've been reading about algorithmic trading, which involves using complicated mathematical and statistical models to profit from market inefficiencies. Usually the gains from each trade are small, but when added together, they can generate huge returns.

But why don't these trading firms simply buy a good stock, and hold the position until they make a profit?

(1) Pick a stock with good long-term fundamentals and strong short-term momentum.

(2) Set the price target at 1% higher than the current price (1% is pretty easy to achieve, because of short-term price fluctuation and the fact that the stock has upwards momentum).

(3) Buy the stock, and wait until the price hits the target.

(4) Sell the stock, rinse and repeat.

While gaining 1% per trade may not seem to be much, but when added together, they can generate huge profits.

So why don't trading firms simply do this? It seems to be a much more easier strategy than using complicated algorithms to look for small arbitrage opportunities or whatever.

EDIT:

Someone asked a similar question on Quora, but the answers are not what I am looking for......

https://www.quora.com/How-do-traders-lose-money-For-example-if-a-trader-buys-can%E2%80%99t-they-just-keep-waiting-until-the-price-goes-above-what-they-bought-it-for-even-if-they-have-to-wait-for-a-few-days

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    What makes you think that the stock will ever reach your +1% price target? – Flux Oct 13 at 5:49
  • +1% may be easy to achieve, but so is -1%. When you reach -1%, you will need more than +1% just to break even, and more than +2% to make your target profit. – Flux Oct 13 at 5:51
  • Obligatory Will Rogers quote: "Don’t gamble! Take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it." – Pete Becker Oct 13 at 12:45
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In poker, the 'rake' is the fee taken on each hand by the operator of the game. The amount of the rake depends on the predetermined rules and this is what generates revenue for the house.

So why doesn't the house play the game (as you suggest) rather than just collect the rake? Because playing the game entails risk which can lead to losses, sometimes large, whereas there's no risk involved with collecting the rake on every hand.

Latency arbitrage is a high-frequency trading strategy used to front run trading orders and like the rake, it skims a very small amount off the top of trades made by traders and investors. It's almost riskless because the trades occur in a fraction of a second.

Like the house in poker, why would HFT take on the risk of playing the game when they can just skim profits off of the game?

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Because sometimes you’ll turn out to have bought at the peak, and the price will never go 1% above what you paid, or at least won’t do so for years. This only has to happen once to wipe out your strategy, and it may wipe out your entire investment if the company goes bankrupt. Stocks with “upward momentum” are especially likely to be in this category, because what that really means is “high volatility”.

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  • But what if I diversify my trades? Like, I trade a 50-100 of these momentum stocks, and one loss in one of these stocks won't wipe out my entire portfolio? – Anonymous Oct 13 at 7:44
  • @Anonymous Then you’re just a rules-based trader, but with a rule that makes you trade frequently, and so dealing costs will ensure that you significantly outperform the market. – Mike Scott Oct 13 at 8:34
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    @MikeScott Underperform, not outperform, right? – nanoman Oct 13 at 8:40
  • @nanoman Yes, you’re right of course. My mistake, and too late to edit. – Mike Scott Oct 13 at 9:39

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