How Quantitative Trading is Reshaping Business Strategies and Profits

Quantitative Trading

A lot of us are in the business of quantitative trading because it is exciting, intellectually stimulating, financially rewarding, or perhaps it is the only thing we are good at doing. But for others who may have alternative skills and opportunities, it is worth pondering whether quantitative trading is the best business for you.

Despite all the talk about untold hedge fund riches and dollars that are measured in units of billions, in many ways starting a quantitative trading business is very similar to starting any small business. We need to start small, with limited investment (perhaps only a $50,000 initial investment), and gradually scale up the business as we gain know-how and become profitable.

In other ways, however, a quantitative trading business is very different from other small businesses. Here are some of the most important.

Scalability:

To a certain extent, quantitative trading is much more scalable than the majority of tiny firms (except from some dot-coms). As long as your approach is continuously profitable, it is possible to find yourself trading millions of dollars from the comfort of your own home. The reason for this is that scaling up often simply requires changing one program variable. This amount is what we call leverage. You don’t need to bargain with a banker or venture investor to secure additional funding for your business. That is what the brokerages are ready to do. If you are a member of a proprietary trading firm, you may even be able to obtain leverage that is much greater than what is allowed by Securities and Exchange Commission (SEC) Regulation T (more on this later in Chapter 4 on beginning a business). It is not unheard of for a proprietary trading firm to let you trade a portfolio worth $2 million intraday even if you have only $50,000 equity in your account (a ×40 leverage). At the same time, quantitative trading is definitely not a get-rich-quick scheme. You should hope to have steadily increasing profits, but most likely it won’t be 200 percent a year, unlike starting a dot-com or a software firm. In fact, as I will explain in Chapter 6 on money and risk management, it is dangerous to overleverage in pursuit of overnight riches.

Demand on Time:

Most small enterprises require a significant lot of your time, at least in the beginning. You need to invest comparatively little time in quantitative trading. The quantitative trading industry is highly automated by definition. Occasionally, the system will perform worse the more you manually alter it and override its judgment.

How much time you need to spend on daily quantitative trading depends largely on the level of automation you have achieved. For example, at the hedge fund where I used to work, some of my colleagues seldom ever come into the office more than once a month. The rest of their time is spent at home, where they occasionally log in remotely to their office PCs that are trading on their behalf.

I consider myself to be in the middle of the pack in terms of automation. The largest block of time I need to spend is in the morning before the market opens: I typically need to run various programs to download and process the latest historical data, read company news that comes up on my alert screen, run programs to generate the orders for the day, and then launch a few baskets of orders before the market opens and start a program that will launch orders automatically throughout the day. I would also update my spreadsheet to record the previous day’s profit and loss (P&L) of the different strategies I run based on the brokerages’ statements. All of this takes about two hours.

After that, I spend another half hour near the market close to direct the programs to exit various positions, manually checking that those exit orders are correctly transmitted, and closing down various automated programs properly.

In between market open and close, everything is supposed to be on autopilot. Alas, the spirit is willing but the flesh is weak: I often cannot resist the urge to take a look (sometimes many looks) at the intraday P&L of the various strategies on my trading screens. In extreme situations, I might even be transfixed by the huge swings in P&L and be tempted to intervene by manually exiting positions. Fortunately, I have learned to better resist the temptation as time goes on.

An overwhelming want to manually interfere also arises when I have too much spare time. Consequently, it is essential to engage in other activities throughout the trading day that are more enjoyable and productive than just staring at your trading screen. For instance, you might visit the gym.

When I say that quantitative trading takes up little of your time, I’m referring to the operational part of the firm. If you want to grow your business or keep your current sales from declining due to increased competition, you will need to devote time to research and backtesting new strategies. Researching and developing new strategies, however, is the creative part of any organization and may be done whenever you want. Between the opening and closing of the market, I thus do research, answer emails, talk to other traders, partners, or clients, go to the gym, and so forth. Even though I don’t have to, I work on some of those things on the weekends and in the evenings only when I feel like it.

When I generate more earnings, I will devote more software development resources to further automate my process, so that the programs can automatically start themselves up at the right time, know how to download data automatically, maybe even know how to interpret the news items that come across the newswire and take appropriate actions, and shut themselves down automatically after the market closes. When that day comes, the daily operation may take no time at all, and it can run as it normally does even while I am on vacation, as long as it can alert my mobile phone or a technical support service when something goes wrong. In short, if you treasure your leisure time or if you need time and financial resources to explore other businesses, quantitative trading is the business for you.

The Nonnecessity of Marketing:

This is the main and most obvious way that quantitative trading differs from other small businesses. For most small businesses, marketing is crucial because you make money from clients who base their purchasing decisions on criteria other than price. Your counterparties in the financial industry only take price into account when making purchases while trading. There is no marketing to be done in a quantitative trading business unless you are handling money for other people, which is outside the purview of this website. Although this may seem simple and trivial, it has a significant impact since quantitative trading allows you to focus solely on your product the software and strategy and not on anything related to how other people see you. Many people believe that this is the most enticing part of starting their own quantitative trading business.

Read Also; Who can become a Quantitative Trader?