Investment algorithms have become increasingly popular, attracting cautious and technologically enthusiastic investors who want a safe, reliable way to make investing decisions. So far, they've been successful in securing their investors a return on their investments, and they keep getting better as automated trading companies like Wealthfront and Betterment continue investing in better technology.
But is there a limit to how far these algorithms can progress? Or a limit to how much we can rely on them for the future of our investments?
How Algorithms Are Effective
First, let’s take a look at how algorithmic trading works and how these companies have managed to succeed thus far. It sounds futuristic and complex, but the realities of algorithmic trading are no more complex than Google search or similar algorithmic processes.
Though each company uses a proprietary algorithm, with different specific processes, all algorithms operate by following a core set of rules. These rules may include things like “buy a stock when its 30 day moving average moves beyond its 100 day moving average,” or “sell a stock when its 30 day moving averages falls below its 100 day moving average.”
Accordingly, algorithms are effective for helping investors secure the best possible price for equity investments, and curtailing losses as proactively as possible. Because these algorithms operate automatically, they also reduce the amount of errors made by human brokers—and decrease the total costs for overseeing such a system.
There are some variants to how algorithms specifically make decisions. Most focus on a combination of trend monitoring and intelligent rebalancing, selecting different types of investments based on the specific investor’s tolerance for risk, and basing most decisions based on how they compare with broader market trends.
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