How the Little Guy Can Compete Against Computers and Index Funds

 | Jun 17, 2017 | 10:00 AM EDT
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There is no question the market has undergone fundamental changes in recent years. Emotions, fundamentals and news no long impact the market like they did in the past. The clear majority of the action is completely unrelated to the sort of research that analysts and strategist offer.

There is no way the average individual investor can compete with the complexity and speed of computerized traders. Many have given up trying and have put their cash into index funds. Those index funds look great in a market that has been in an uptrend for years, but they will lose appeal quickly when the cycle finally turns.

When I wrote my book "Invest Like a Shark" my main thesis was that the little guy shouldn't try to compete by acting like miniature mutual funds. The key was to use the unique advantages of speed and flexibility that big funds do not have.

While that still works to some degree, the big funds have become more like aggressive individual traders and use shorter time frames and greater flexibility. High-frequency trading has taken that idea to the extreme and uses time frames that no human being can match.

So, what should individual traders do to regain an advantage? The answer is that they need to shift their time frames, be less reactive to volatility and wait patiently for trades to develop.

Chart patterns still work, but they work differently. There are now more V-shaped moves as the computers will manipulate patterns that are the most obvious in the short term, but ultimately when good fundamentals drive better price action there still is momentum that can be captured.

Ironically, the individual investor's best strategic tool now is patience and speed. You need to learn to let a trade work rather than react to the noise the quants and algorithms create. They are going to try to shake you out of trades by making you question your logic. The computer programs are designed to take advantage of normal emotional reactions. To combat that you need to not react in the normal fashion. That requires patience and a greater tolerance for volatility.

The best way to deal with quants and algorithms is to be aware of how they are designed and what they are trying to achieve.They have changed the way stocks trade, and rather than fight that we need to embrace that fact.

There are some very smart people who develop these strategies and we are going to have a very hard time trying to compete with them by doing the same thing. We need to take into account the way they think but find ways to bypass the impact they have on price action.

Individual traders no longer have any great speed advantage, but they do have the flexibility to change holding periods and adapt to a market that doesn't trade like it used to. I'll be going into more detail about trading in the world of quants and algorithms, but at the heart of effective trading is a very old concept -- patience.

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