Stock Exchange: Can Humans Compete with High Frequency Traders?
Many individual investors have been frustrated by the growing prominence of High Frequency Trading. Complicated algorithms can process new information and react in fractions of a second. It sounds intimidating, and in some sense, it is. Individual Investors would be poorly suited for direct competition.
Instead, stick to what the market is giving you. The connections made by these programs are often spurious – totally unrelated to the fundamentals of a given business. This is intentional. After all, they’re after a quick buck rather than a long-term investment.
For that reason, a stock being walloped for frivolous story in the 24-hour news cycle may present an attractive buying opportunity. It all comes down to the individual investor’s process and commitment to their goals.
This Week—Holmes sniffs out a deal
It can be tempting to make a trading decision based on a glance at its recent chart. Unfortunately, a stock that has underperformed in recent days might be providing a big opportunity. Holmes uses a mix of advanced trading techniques and technical analysis to avoid significant drawdowns. When he chases after a down stock, it’s because he sees some serious upside. Let’s see what he’s up to this week:
Holmes: This week I’m buying Jack-in-the-Box (Jack) a restaurant chain in the U.S. (95.98).
It’s not easy finding stocks that fit the exact criteria I’m looking for. I try to find stocks that have been trending higher, then have broken down below that trend, and have started to base a for reasonable period of time.
This gives me a good entry with limited downside risk and upside gains that may get back to the previous levels before the most recent debacle. I like risk/reward ratios of 2:1 or better. With Jack, my downside is 93.70(Stop), my upside is 106, risking $2.28 to make $10.02. Woof Woof!
Brian: a comp miss sent the stock down to its 200-day moving average after February ’17 comp’s for JACK as the industry that the “low-end” consumer has taken a breather. Forward earnings and revenue estimates are a little weaker following the February ’17 miss, but JACK is trading at 20(x) expected ’17 earnings for expected 17% growth. Even if EPS growth slips to 15% or even low teens the stock is cheap on a PEG (P.E to growth) basis.
Holmes: Glad to hear you approve! Jeff is usually a bit harsher.
Brian: It’s not a bad pick, depending on how long you’re holding onto this one.
Holmes: My usual target is about 4-6 weeks, though I wouldn’t hesitate to unload this if another downturn became apparent.
Brian: Solid reasoning – for a talking dog, at least…
Oscar: My big pick this week is the China Large-Cap ETF (FXI).
We’re in the midst of March Madness, so let’s call this pick a rebound. Not in the classic sense: that’s better suited for FXI’s behavior through early January.
Still, I made this my pick on 2/9 and hung with it for a couple of weeks. Now that we’ve seen another drop, I’m ready to jump off the bleachers and get back in the game.
Brian: BRIC’s and Emerging Markets have traded well since the bottom in Q1 ’16. FXI is the safer asset class in a crowded China ETF market. As someone who was never a fan of China as a strategic or even tactical asset allocation recipient, Emerging Market ETF’s might be a better risk / reward. The ETF is scraping along its 200-day moving average.
Oscar: So, you like this one too?
Brian: I’ve always thought China was like playing the US stock market in the late 1800’s – it is the Wild Wild West of outcomes, as a Communist country tries to centrally plan a free-market economy.
Oscar: It’s a risk I’m willing to take!
Continental Resources (CLR) is my next long position.
The decline here has been sustained and significant, which I find attractive. At $43.22, there is definitely potential for the stock to improve near previous highs above the $55 mark. I could hang onto this one for months.
Brian: Continental took a beating on Wednesday as crude oil fell 5%. The Energy sector is a battleground sector as crude gyrates around $50 per barrel and CLR is leveraged to the price of crude. The stock is oversold and trading below its 200-day moving average.
Felix: I agree the stock is oversold, but I don’t like the sound of that “battleground.” How do I know when I’ve hit a proper valuation here?
Brian: Tell me what crude oil will do and you can figure out what CLR will do.
Felix: Uh oh.
Athena: I understand my methods are often met with skepticism. That’s why I like to pause now and then and reflect on some small successes. Let’s review my recent foray into Advanced Micro Devices (AMD).
I recommended this stock back on 2/9/17, just after a huge spike in price. Put lightly, this was not my most-loved pick. That was fine by me. Because I had the right time frame in mind, I was able to collect a tidy sum and close out this position near the end of the month.
Brian: A semiconductor company that was a serial capital destroyer for most of its life and long an “also-ran” to Intel, AMD had an impressive string of “earnings beats” and raises in 2016. On the other hand, the valuation is stretched with the Street looking for $0.07 and $0.26 thus AMD is trading at 50(x) next year’s earnings.
Athena: Would you say something like this might be due for another pop in the near future? How hot is this trend?
Brian: The semiconductor space looks good both technically and fundamentally, and AMD is a resurgent laggard in the space.
Background on the Stock Exchange
Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.
The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert or stock.
If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).
The growing establishment of High Frequency Trading algorithms has changed the investment landscape. However, that doesn’t spell doom for the individual investor. Overreactions to trivial matters, like a POTUS tweet, can actually create bargain opportunities. Keep these ideas in mind:
- Do not compete directly by trying to react more quickly to news.
- Find a method that differs in time frame.
- Do not use stops that become limit orders. A random move can take you out of a position at a poor price.
- If possible, use the HFT algorithms to your advantage. If a stock is solid, consider buying dips by having some standing buy orders.
Take what the market is giving you.