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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

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    Read up on "high frequency trading". There are indeed people doing this sort of thing, and it's not as trivial as your question makes it out to be. More info on hft would be at quant.stackexchange.com versus this site. – bstpierre Mar 23 '11 at 14:46
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    Better forget about it. There are people and big banks who have decades of headstart over you and the money muscle to make you disappear into oblivion. If you have an idea not practised till now and you can prove it works or if you have it working, you can have my money. – DumbCoder Mar 23 '11 at 15:51
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    We're having a discussion about this very question (and these types of questions on the meta). Feel free to join us. – George Marian Mar 24 '11 at 0:44
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    Whenever I hear "fool proof way", I cringe – BlackJack Aug 12 '11 at 13:58
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    Isn't this how Lex Luthor got rich in the Superman films? – gef05 Aug 12 '11 at 17:46
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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).

  • Thank you for your aware, I was starting to come to the same conclusion myself, but it's nice having it confirmed. – Ole Mar 23 '11 at 16:41
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    @Ole, it's a common problem with trading strategies - a lot of them work really well if you don't take transaction costs and bid/ask spread into account and fall flat on their faces if you do... – Timo Geusch Mar 23 '11 at 23:26
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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.

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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!

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