Quantitative Trading: Is It For You?


Wikipedia calls them “quantitative analysts,” people who specialize in the application of mathematical and statistical methods to financial and risk management. Investopedia calls it quantative trading and describes it as a trading strategy that relies on mathematical computations and number crunching to identify trading opportunities. These days quantitative trading is becoming more commonly used by individual investors. You can shorten the moniker to quant investing, or quants. These are the people who create computer algorithms that invest into the equity markets.

Quants and Investing

It seems like a no-brainer. Computers do a great deal of today’s work. Computers are everywhere. Cars quit being analog back in the 80s when points and timing guns became obsolete. Homes, airplanes, communications, are all highly computerized. And why not? Computers work tirelessly, 24/7. They avoid other human weaknesses such as biases and emotional factors. They simply use the data presented to them, and the financial data computer's crunch is too large and subtle for any human to discern patterns or meaningful value. Ok, computers should do a better job than humans in finding trading opportunities. Is there a drawback?

Yes, one could argue that humans should and need to be the final decision-makers in a computerized system. An example would be the Air France flight from Rio de Janeiro to Paris. The flight computer had calculated the wrong airspeed data due to an iced-up pitot tube. Computer disaster, I agree. Even in a world of instant computer decisions, an experienced operator should have an abort option. We’ve heard of the flash crashes where sell orders came in at cents on the value of the stock, mainly because no human said “Wait, this is absurd.” Ok. Then let’s let computers do the work and then an experienced human operator should be present to review any actions taken. Fine. That makes sense. But, that isn’t how today’s individual investors or even most firms invest their funds. Sadly, they’re missing out on the better returns quants are achieving. Why? Quants are a new phenomenon. There’s a book on this subject written by Scott Peterson titled, The Quants. Where are those quants?

You may have to look, but I think the next term, creative destruction, will show you that more quants are coming quickly. (For related reading, see: Quant Strategies—Are They for You?)

Creative Destruction

This is the process in capitalism whereby new ideas and inventions destroy and replace the current structure. The old structure will usually resist the change quite vigorously, including politically. We see it everywhere. Horse buggy builders, gone. Pay phones, almost gone. Some say it’s happening in retail brick-and-mortar stores, Amazon and UPS bringing them concern. Record shops? Video stores? Kodak film? They usually don’t go without a fight for survival. Can’t blame them. But progress can’t be stopped either…only slowed by the old structure.

How does creative destruction affect my financial decisions? I believe quants are the change coming to the investment world. The old structure isn’t equipped to handle computerized trading. The new proposed fiduciary rule scares them for many reasons, but mostly because their old business model isn’t lining up with the new processes. They make money the old-fashioned way. I won’t explain, it would step on too many toes. If the fiduciary rule scares them, the fight for survival, as I said earlier, can get political. You can see it, read current financial news. Investment companies are fighting the rule change. Plus maybe you’ve heard the term robo-advisors?  That’s a new term which describes investment allocation decisions mostly made by computers. You can’t fight efficiency. I believe the old structure is slipping away and the new order will be an efficient improvement.  Combined with experienced humans keeping a watchful eye on those stinking machines. 

So, where are the quants? They are out there. Making a difference. Just need to look.

In closing, a quote:

“I have noticed that even those who assert that everything is predestined and that we can change nothing about it, still look both ways before they cross the street.”
― Stephen Hawking