Idea for getting rich using computers to track stocks

Question

Hallo,

I have been toying with this idea in my mind for a while now and to me it sounds like a fool proof way of getting 'rich'. I'm sure someone has had the same idea as me, maybe even tried it, and because not everyone is doing it I'm guessing it did not work out very well.

The idea is to make money on small changes in the stock market. From looking at different stocks it looks to me that most stocks go up and down a certain amount at the time. The amount changes, but if there is a positive change in a stock it tends to stay positive for a bit before going negative again.

Could you not write a computer program to track this changes and invest in a stock after it has shown a positive grown for a small period of time and sell again as soon as the change starts to become negative. This would not give a big percentage increase on your investment, but as a computer could track thousands of this trades simultaneously for 24 hours a day I'm sure the overall return could be quite good.

To me the idea sounds fool proof, but I'm sure there are reasons for why people do not do this, I am mainly interested in why. Maybe it breaks trading rules? Maybe you can't buy stocks from a homemade computer program or something else entirely?

Thanks

Answer 1

The main reason I'm aware of that very few individuals do this sort of trading is that you're not taking into account the transaction costs, which can and will be considerable for a small-time investor. Say your transaction costs you $12, that means in order to come out ahead you'll have to have a fairly large position in a given instrument to make that fee back and some money. Most smaller investors wouldn't really want to tie up 5-6 figures for a day on the chance that you'll get $100 back.

The economics change for investment firms, especially market makers that get special low fees for being a market maker (ie, offering liquidity by quoting all the time).

Answer 2

I (and probably most considering trading) had a similar thought as you. I thought if I just skimmed the peaks and sold before the troughs, perhaps aided by computer, I'd be able to make a 2% here, 2% there, and that would add up quickly to a nice amount of money. It almost did seem "foolproof".

Then I realized that sometimes a stock just slides...down...and there is no peak higher than what I bought it for. "That's OK," I'd think, "I'm sure it will recover and surpass the price I bought it for...so now I play the waiting game." But then it continues sliding, and my $10k is now worth $7k. Do I sell? Did I build a stop loss point into my computer program? If so, what is the right place to put that stop? What if there is a freak dip down and it triggers the stop loss but THEN my stock recovers? I just lost $14,000 like this last week--luckily, only virtually!

The point is, your idea only has half a chance to work when there is a mildly volatile stock that stays around some stable baseline, and even then it is not easy. And then you factor in fees as others mentioned... People do make money doing this (day traders), and some claim you can use technical analysis to time orders well, so if you want to try that, read about technical analysis on this site or elsewhere.

Answer 3

There are many ways to trade. Rules based trading is practiced by professionals. You can indeed create a rule set to make buy and sell decisions based on the price action of your chosen security. I will direct you to a good website to further your study: I have found that systemtradersuccess.com is a well written blog, informative and not just a big sales pitch. You will see how to develop and evaluate trading systems.

If you decide to venture down this path, a good book to read is Charles Wright's "Trading As A Business." It will get a little technical, as it discusses how to develop trading systems using the Tradestation trading platform, which is a very powerful tool for advanced traders and comes with a significant monthly usage fee (~$99/mo).

But you don't have to have tradestation to understand these concepts and with an intermediate level of spreadsheet skills, you can run your own backtests.

Here is a trading system example, Larry Connors' "2 period RSI system", see how it is evaluated: http://systemtradersuccess.com/connors-2-period-rsi-update-2014/, and this video teaches a bit more about this particular trading system: https://www.youtube.com/watch?v=i_h9P8dqN4Y

IMPORTANT: This is not a recommendation to use this or any specific trading system, nor is it a suggestion that using these tools or websites is a path to guaranteed profits. Trading is a very risky endeavor. You can easily lose huge sums of money. Good luck!