Quantitative investment and trading ideas, research, and analysis.
Thursday, September 20, 2007
So how much did quantitative strategies actually lose last quarter?
The numbers have started to come in: Morgan Stanley lost $480MM last quarter due to quantitative trading -- about 10% of operating profits.
15 comments:
Anonymous
said...
Hi Ernest,
The half billion loss of Morgan Stanley can be viewed as a form of wealth re-distribution. Do you think savvy and nimble retail-quantitative-traders can discover and exploit opportunities like this, and get a fair share of their services as market-liquidity-facilitators ?
What edges do you see in the retail traders to beat the institutional traders? It seems that the professionals know that their days in trading public equities are numbered. Evidence is that D.E. Shaw is re-direct its battle field to private equity. Indeed, much of the firm's growth in recent years has come from an expansion into other types of investing, such as private equity and distressed debt and lending. Apparently, the Robin Hood Regime won't last forever.
The advantage that retail investors enjoy is that they can pursue strategies which have low capacities. Those strategies can typically trade at higher frequencies or trade stocks with smaller liquidity than hedge funds do. This is an advantage that will endure for retail investors, unless certain hedge fund managers decide to develop hundreds of profitable strategies each with small capacities.
For the wealth transfers as mentioned in "The Robin Hood Regime", day-traders have to be in the opposite position against the gigantic hedge funds. It seems that the 'low capacity' edge of the retail investors are not the key factor to become Robin Hoods, bacause there is just no existence of giantic hedge funds there. George
I believe the essential edge here is high frequency. Small book size is just a necessary condition for high frequency trading. If your position in a stock is a million shares, there is simply no liquidity available for you to enter and exit this position within, say, an hour.
I don't quite know what you mean by "trading with market noise". If you have a price series that exhibits stationary white noise (i.e. it is "integrated with order zero"), then we can have a very profitable high frequency mean-reverting trading strategy.
For further reference on time series analysis, you can look up the Market Models book in my Recommended Books list.
What I meant by 'market noise' is the same as Fisher Black in his "Noise" article. As he put it, the information trader make their profits from the noise traders. One big pitfall of the mean reversal strategy is that it requires stationarity, which is a problem at market break out points.
Hi George, I believe that the dichotomy between "informed traders" and "noise traders" is an artificial one. In the real marketplace, traders have varying degrees of information, varying kinds of information, and indeed varying interpretation of information. Furthermore, traders trade at different time scales, and though "informed" traders may have an edge over the long term, it is by no means certain that at a short time scale they have an edge over a "technical" trader. August has been an excellent demonstration of this.
It is also true that only experienced, astute traders can identify conditions under which short-term stationarity holds and mean-reverting traders are favorable.
Thanks for the enlightening discussions! When you said "..astute traders can identify conditions under which short-term stationarity holds..", did you mean that successful trading is an art more than science? Bennett Goodspeed put it so well in "The Tao Jones Averages" that by making science out of an art, the so-called investment professionals are opting to be precisely wrong rather than generally correct. Western mentality with its analytic ways tends to make fixity out of flux, more like attempting to understand running water by catching it in a bucket. For you, what is the percentage of art and science in successful trading?
Hi George, By "experience" and "astuteness", I do not mean anything more than the general business knowledge and process optimization know-how acquired by the management of any business. If practiced by a non-algorithmic trader, it can be an art. If practiced by an algorithmic trader, it is a science. In my opinion, there is nothing about this know-how that cannot be automated, at least in theory. Ernie
Massive deployment of automated trading strategies by some big players have made the market much more efficient, hence less profit opportunities. That is the main reason that D.E.Shaw expands to other types of investment. It is obvious that nowadays only high-frequency quantitative traders can exploit the sporadic and instantaneous inequilibrium in the market. So far, you are the only retail quantitative trader that I know. For technical traders, there is a Market Technicians Association for then to exchange ideas and enhance their trade. I'm wondering if there exists a Quantitative Traders Association (QTA) for retail traders? I myself joined the IAFE but not very satisfied,this organization is for financial engineers working for big institutions, it is by no means an organization for retail quantitative traders. Since you're already a pioneer in this field, do you have any interest to become the founder of QTA ? :-)
Hi George, I have found that blogging has been the most efficient way to exchange ideas with other traders, retail or otherwise. It beats attending most conferences or seminars.
One can get ideas from many diverse online forums and then turn them into quantitative strategies. Ernie
15 comments:
Hi Ernest,
The half billion loss of Morgan Stanley can be viewed as a form of wealth re-distribution. Do you think savvy and nimble retail-quantitative-traders can discover and exploit opportunities like this, and get a fair share of their services as market-liquidity-facilitators ?
Hi George,
Yes, that was exactly my point in the article The Robin Hood Regime as well.
Ernie
Hi Enrine
What edges do you see in the retail traders to beat the institutional traders?
It seems that the professionals know that their days in trading public equities are numbered. Evidence is that D.E. Shaw is re-direct its battle field to private equity. Indeed, much of the firm's growth in recent years has come from an expansion into other types of investing, such as private equity and distressed debt and lending.
Apparently, the Robin Hood Regime won't last forever.
George
Hi George,
The advantage that retail investors enjoy is that they can pursue strategies which have low capacities. Those strategies can typically trade at higher frequencies or trade stocks with smaller liquidity than hedge funds do. This is an advantage that will endure for retail investors, unless certain hedge fund managers decide to develop hundreds of profitable strategies each with small capacities.
Ernie
Earnie,
For the wealth transfers as mentioned in "The Robin Hood Regime", day-traders have to be in the opposite position against the gigantic hedge funds.
It seems that the 'low capacity' edge of the retail investors are not the key factor to become Robin Hoods, bacause there is just no existence of giantic hedge funds there.
George
Hi Ernie,
Sorry for all the previous typos of your names
George
Hi George,
I believe the essential edge here is high frequency. Small book size is just a necessary condition for high frequency trading. If your position in a stock is a million shares, there is simply no liquidity available for you to enter and exit this position within, say, an hour.
Ernie
Hi Ernie,
High-frequency trading is trading mostly with market noises. Don't you think, in the long run, it has no edge at all ?
Hi George,
I don't quite know what you mean by "trading with market noise". If you have a price series that exhibits stationary white noise (i.e. it is "integrated with order zero"), then we can have a very profitable high frequency mean-reverting trading strategy.
For further reference on time series analysis, you can look up the Market Models book in my Recommended Books list.
Ernie
Hi Ernie,
What I meant by 'market noise' is the same as Fisher Black in his "Noise" article. As he put it, the information trader make their profits from the noise traders.
One big pitfall of the mean reversal strategy is that it requires stationarity, which is a problem at market break out points.
George
Hi George,
I believe that the dichotomy between "informed traders" and "noise traders" is an artificial one. In the real marketplace, traders have varying degrees of information, varying kinds of information, and indeed varying interpretation of information. Furthermore, traders trade at different time scales, and though "informed" traders may have an edge over the long term, it is by no means certain that at a short time scale they have an edge over a "technical" trader. August has been an excellent demonstration of this.
It is also true that only experienced, astute traders can identify conditions under which short-term stationarity holds and mean-reverting traders are favorable.
Ernie
Hi Ernie,
Thanks for the enlightening discussions! When you said "..astute traders can identify conditions under which short-term stationarity holds..", did you mean that successful trading is an art more than science?
Bennett Goodspeed put it so well in "The Tao Jones Averages" that by making science out of an art, the so-called investment professionals are opting to be precisely wrong rather than generally correct. Western mentality with its analytic ways tends to make fixity out of flux, more like attempting to understand running water by catching it in a bucket. For you, what is the percentage of art and science in successful trading?
George
Hi George,
By "experience" and "astuteness", I do not mean anything more than the general business knowledge and process optimization know-how acquired by the management of any business. If practiced by a non-algorithmic trader, it can be an art. If practiced by an algorithmic trader, it is a science. In my opinion, there is nothing about this know-how that cannot be automated, at least in theory.
Ernie
Hi ernie,
Massive deployment of automated trading strategies by some big players have made the market much more efficient, hence less profit opportunities. That is the main reason that D.E.Shaw expands to other types of investment. It is obvious that nowadays only high-frequency quantitative traders can exploit the sporadic and instantaneous inequilibrium in the market.
So far, you are the only retail quantitative trader that I know. For technical traders, there is a Market Technicians Association for then to exchange ideas and enhance their trade. I'm wondering if there exists a Quantitative Traders Association (QTA) for retail traders? I myself joined the IAFE but not very satisfied,this organization is for financial engineers working for big institutions, it is by no means an organization for retail quantitative traders.
Since you're already a pioneer in this field, do you have any interest to become the founder of QTA ? :-)
George
Hi George,
I have found that blogging has been the most efficient way to exchange ideas with other traders, retail or otherwise. It beats attending most conferences or seminars.
One can get ideas from many diverse online forums and then turn them into quantitative strategies.
Ernie
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