We live in a fast-paced world. This motivates many people to automate menial tasks, including investing.
That may work for a while, which gives you a false sense of security. This false sense then may entice you to commit more capital than you should.
If it works for $100 trades, it should work for $1,000 trades, right?. This is how greed sets in, and that can be the downfall of any portfolio.
Another problem is that other traders watch when something is working and pounce on it. They subscribe to the robotic trading program and reverse-engineer the software.
Then they hire someone who can produce code quickly and start using it for themselves or sell it to others. The net effect is that the process becomes less effective for everyone.
You might wonder how traders learn to reverse engineer each other’s systems. It all has to do with claims made by the companies programming the robots.
Wouldn’t you want to trade with someone who claims a 90% success rate? Scalping traders quickly steal these systems.
Then, there is the problem of intense competition among robot programmers. The more robots that exist the tougher it becomes to find ones that do work and who aren’t making egregious claims.
Passive vs. programmed
Iconic billionaire investor Warren Buffett made a bet back in 2007 that he could beat any company who engaged in active trading, including robotic trading.
The bet ended in 2017. The hedge fund company challenger conceded months before the bet was concluded.
Buffett used an index on the S&P 500. He was so far ahead that the hedge fund manager had no choice but to throw in the towel.
Why did Buffett win the bet? Part of the reason is that he didn’t overtrade. Every trade you make — or have a robot make for you — generates a commission for your broker.
This is something that will plague any robot-trading solution. Many robots trade in and out multiple times per day. The commissions on this alone will eat into the profits of most portfolios.
Buffett didn’t have this problem.
Furthermore, don’t confuse a robotic solution with passive investing. Buffett advises that people invest in an index fund, such as the S&P 500.
The returns of most investment pros eventually revert to the mean, and the mean is typically represented by an index fund.
Over the long run, then, most managers are incapable of beating the index.