What is Quantitative Trading and How Do I Learn It?

What is Quantitative Trading?

The point of quantitative trading is to long or short a financial asset when its price is not what (we think) it should be.

The difference from manual trading is that either the decision making process is done quantitatively or trade execution is done automatically by a machine.

To represent that in logic form:

If X happens, Y should happen.

If Y doesn’t happen, we do Z in anticipation that Y will happen.

For instance, if satellite images of all Walmarts show an increase in the number of parked cars (which implies an increase in shoppers), the price of Walmart should rise.

If the price doesn’t rise, we buy the stock in hopes that it does (especially during the next quarterly earnings announcement).

When should we use Quantitative Trading? (Instead of Manual Trading)

We use quantitative trading when the market opportunity is persistent, which means it appears over and over in a similar fashion.

We use manual trading when the market opportunity is one-off.

Why should we use Quantitative Trading?

We use quantitative trading because we want to:

• Analyse large amounts of data
• Analyse data quickly
• Analyse text or images (using machine learning)
• Collect large amount of data (web scraping)
• Fire a trade with lightning quick reactions
• Fire many trades in a short time
• Fire a trade where you need a precise price
• Monitor the markets 24/5 or 24/7

What are some examples of Quantitative Trading Strategies?

What are some examples of Manual Trading Strategies?

In contrast, here are some examples of manual trading strategies.

• Hedge fund manager George Soros profiting $1 billion betting that the UK was unable to maintain the British Pound above a certain value in 1992
• Winklevoss Twins (the twins that sued Facebook’s CEO Mark Zuckerberg) became billionaires thanks to a $11 million bet on bitcoin in 2013.
• Sending someone to record the number of trucks leaving a timber processing factory every day. Thus, estimating supply and sales. This allows us to predict the timber company’s earnings.

What are the Key Components of Quantitative Trading?

Finance, mathematics and programming. Finance gives us the trading idea, mathematics helps us quantify the opportunity, and programming helps us test and implement the trading strategies.

Learn finance before the math. Learn the math before programming.

Finance

Understanding finance, economics and how the market works is the most important part of quantitative trading. This gives us the skills to identify and find trading opportunities.

In many cases, having knowledge of other specific domains is useful if we are trading products in those industries.

For example, understanding the weather and agriculture process is useful if you are trading coffee futures.

Mathematics

For most trading ideas, you just need high school level statistics.

You need statistics knowledge to calculate how big or small an opportunity is, and to calculate how big your trades should be.

Let’s say a trade wins 50% of the time with a 15% return, loses 40% of the time with a 10% loss and loses 10% of the time with a 100% loss.

Is this a good opportunity? If yes, how much should we trade?

There is a statistical solutions for the two questions above. Go read about Expected Value and Kelly Criterion (this formula is aggressive, use with care to prevent overbetting).

Alternatively, we can run simulations to find the optimal betting size based on multiple potential outcomes of a trade.

Programming

Programming lets you test, improve and deploy your quantitative trading strategy.

Programming is usually the last piece of the puzzle after the initial strategy design phase. However, it is increasingly important as new strategies require technical skills at the onset.

For instance, if we are evaluating comments from web forums and reviews from restaurant review sites for opportunities, we need programming skills to scrape those data.

This has to be done at the initial strategy development phase.

Can an Individual run a Quantitative Trading Strategy?

Yes, an individual can. Software and data is cheap enough for a single person to run a quantitative trading strategy. However, a single person can’t run a high-frequency trading strategy as the costs and technical requirements are too high.

High-frequency trading (HFT) firms spend hundreds of millions for trading infrastructure and have teams of usually very competent computer scientists, data scientists and traders.

It is more than difficult for a single person to win the HFT battle.

Note that just because a single person can run an quantitative trading strategy, doesn’t imply he or she can be profitable in the long term.

Knowing how to play chess and being a chess champion are two very different things.

How to be a Successful Quantitative Trader?

Get into a top trading firm. You’ll gain knowledge, credentials, connections, mentorship and money in one fell swoop!

Well you don’t say!

Yes, it is incredibly difficult to get into top quantitative trading firms without Masters or Ph.D. in a quantitative subject (Computational Finance, Physics, Engineering, Statistics etc).

It is almost impossible if you want to get into a high-frequency trading role without these qualifications (unless your dad owns the firm!).

The good news is that there are ways to get into a decent hedge fund. Here is a list:

• Find a mentor/be an apprentice
• Work backwards from the job descriptions
• Contact those not in the HR department
• Get hired at a lower tier firm (first)
• Get your foot through the door in a related role
• Get good at trading

What are some Resources to Learn Quantitative Trading?

Recommended Books

Related Questions

What are the components of a trading algorithm? A trading algorithm consists of 3 parts – 1) the code to enter a trade 2) the code to close a trade and 3) the code to calculate how much to trade.