What is quantitative trading? Quantitative trading is the buying and selling financial assets using computers, without human intervention. It is done to exploit persistent market opportunities to make profits.
The best way to learning quantitative trading is to join a trading firm or find a mentor and shadow him at work. More details on this later.
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).
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.
» If you want to learn how to beat chess champions (the hedge funds), check out our guide: How Can Retail Traders Beat Institutional Traders and Hedge Funds?
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
More info on getting a job: Trading Jobs – How to Get One and How Much will I Make?
If you are doing it alone without joining a trading firm, you need to understand what is quantitative trading, learn how to spot opportunities, start coding and testing your ideas appropriately, deploy your strategy, make mistakes, try again, lose (hopefully small amounts) money, try again, repeat until successful.
