I have spent some energy lately trying to rationalize why traditional fundamental analysis is very useful in understanding the health of specific businesses but is not nearly as useful in understanding the stock market. The stock market is a different beast than the business world. A knowledge of growing trees and the manufacture of baseball bats does not automatically translate into an understanding of baseball. These are two separate fields of knowledge, that can be bridged and brought together -- but not with new knowledge.
Which brings me to a different question, the title of this essay. WHY PROGRAM TRADING? What is Program Trading? Program Traders seem to be a small elite group of technicians employed by all the most powerful banks and trading houses to...to do what exactly? To program investment trades in such a way that trading becomes automated around certain paradigmatic principles inherent in the market itself. Rising prices with rising volumes is a paradigm. Is it a significant paradigm -- does it suggest a law that defines a pattern? Computer programmers are hired to write programs that assume the stock market is based on laws, or at least on laws of averages.
The Fundamentalists must come into and through the technical analyst's brain on their way into the New World of Computer Programmed trading. The religious believer who never becomes a mystic never really sees God with his mind but always with his belly -- always remains a believer in God but never becomes a knower of God. Note the three stages of religious belief: 1) faith in God through obedience; 2) denial of God through opposition, led by worship of intellect and ego; 3) knowledge of God through mystical synthesis and spiritual unity.
Traditionalists scoff at program trading, or blame it for all the excesses of Wall Street. But program trading is the logical development of the world inside of which we are evolving. Cars are being programmed to drive themselves, to eliminate accidents. This is the essence of our world now, in fact -- a symbol of it, and a symptom of its underlying graces and disabilities.
I read with a mixed amount of bemusement and disbelief rebuttals to my claims that analysis of stocks and analyses of businesses are NOT the same thing. Many readers parade the image of Warren Buffet as a picture of the fundamental man, the true investor, who despises technical information and conquers through his basic knowledge of business. That is the Old World. The Old World is leaving us, as we read this. Do you think any major bank or financial institution in the world is not paying programmers to build a better beast? In a world dominated by program traders, investors also need to be program traders. The algorithm is not going away. The algorithm may help to destroy us -- but it is not going away.
Program trading is already the future. Many traditional investors now use computers to screen for companies with the best earnings momentum or the best earnings per share. The next step is screening for stocks that meet your buy criteria based on your technical understanding of what defines an uptrend or a downtrend, translated into a mathematical formula.
When an investor buys a stock on Wall Street they are not really buying a business, they are buying a stock. The business can do relatively well; and the stock cannot thrive. This is a Bear Market. And they happen every 18 years. This is why an investors needs to understand the behavior of the stocks they buy as well as the behavior of the business -- but these are two different branches of knowledge.
Program trading (trading programs written by computer programmers) is not going away. It is the wave of the future.