Think Realty sat down with Bryan Ellis, the founder of Self Directed Investor (SDI) Society, to discuss this burgeoning trend of the automated trading system.
How would you like to put a nice chunk of money into your retirement account, press the “easy” button, and then just wait for your account to start churning out profits? If that sounds good to you, then the creators of automated trading systems software are hoping you will let their systems handle your investing from start to finish.
What is an automated trading system?
Imagine that you found a “profit pattern” in the stock market, like maybe you’ve discovered that every time Company X jumps in value by 5% or more, then Company Y will jump by 15% within 30 days. That’s a ridiculously simple example, but for our purposes, it will do. So if you’re convinced the pattern you’ve discovered is relevant, you might choose to invest some of your portfolio to take advantage of it. And that’s where automated trading systems come into focus. An automated trading system is a piece of software that detects when those types of profit patterns have occurred in real time, and can automatically enter trades to your broker so you don’t miss those opportunities.
This sounds very promising. Is there any downside?
Yes, it is promising, without a doubt. If you’re a trader of stocks, bonds, forex or other conventional financial assets, and if you’re both well-versed in the disciplines of technical analysis and in computer programming, then these systems are well-suited to you and can be very helpful.
But let’s face it: Most people are not experts in either technical analysis or computer programming. Without both of those skills, automated trading systems can easily magnify your investment risk rather than reducing it. Like any other powerful tool, automated trading systems can be a powerful help or a great danger, depending on who is using it.
A booming trend in the financial services industry is the “robo-adviser” in which your financial services firm turns over the investment management decisions of your portfolio to a computer rather than letting it be handled by a human adviser. Is this the same as an automated trading system?
It’s not the same, but it’s very similar. The distinction is that when you’re using a robo-adviser, you don’t need to know any patterns or technical analysis or computer programming because the financial firm makes all those decisions for you. They pick their own profit patterns and code those patterns into their own automated trading system, and their system then manages your portfolio. In essence, using a robo-adviser means you’ve hired a financial firm to run an automated trading system on your behalf.
This sounds like it could be very risky to an investor’s portfolio. Is it?
Well, sure, it can be very risky, either as a direct user of automated trading systems or as a client of a robo-adviser. Look, I’m not going to tell you that you can’t be profitable using automated systems particularly or stocks in general. It clearly is possible to be profitable with that asset class. But there are so many examples of companies that were absolute darlings of Wall Street with stellar reputations – like Enron and Lehman Brothers – which suddenly and unexpectedly crumbled under the weight of their own poor, dishonest management, causing massive losses and financial pain to their shareholders. That sort of thing is a function of the fact that stocks are, at their core, just a paper asset with nothing backing them up.
Think about all those people who lost billions to Bernie Madoff. Most of those people were wealthy, accredited investors, but it was easy for Madoff to lie to them – even though they were savvy investors – because he didn’t have to give them anything other than account statements, which we now know were all falsified. Think of how their lives would be different right now if their investments had been protected with physical asset collateral like real estate or precious metals. I can tell you how their lives would be different: They wouldn’t have been slaughtered financially. It’s that type of risk – the risk of absolute, 100% loss – that is a core and indivisible risk of investing in paper assets like stocks, and neither automated trading systems nor robo-advisers can mitigate that danger.
You sound very negative on automated trading systems. Are there any circumstances under which a person should use these tools?
Well, yes, of course, there are circumstances like that. In fact, I’ve used them myself, in the distant past. About 20 years ago, before I concluded that real estate was a fundamentally superior asset class to stocks, I was a full-time trader of stocks and equities for my own clients, and I used automated trading tools to assist me in trading a pattern I’d discovered. That technology was incredibly helpful to me, because my pattern was very reliable, but it only produced a couple dozen trading signals per year, and it was not possible for me to predict in advance which stocks, among literally thousands of publicly traded companies, would fit the pattern. So for me – and people in a similar situation – automated trading tools were very helpful.
But it’s important to note that I have both a vast background in computer programming and a strong understanding of technical analysis, so for me, this type of tool was a natural extension of my skills. If that’s your background and you insist on investing in paper assets, then automated trading systems can be a good fit for you. But if your background is less perfectly matched than that, then it’s my humble opinion that these trading systems are more likely to automate losses rather than profits in your portfolio.
From a real estate perspective, is there anything that’s comparable to the hands-off nature of automated trading systems?
Sure, there is. Two things that come to mind are turnkey rental properties and real estate-secured notes. The former is a rental property where all of the details – renovation, leasing and management – are handled for you as part of the deal. The latter is just a loan that produces cash flow for you, but it’s secure with great real estate collateral that makes it very safe. These strategies are essentially the “easy button” for cash flow property investing, and these asset classes are really booming in popularity among savvy, affluent investors, certainly including our members in the Self Directed Investor Society.