What Is Quantitative Trading?

Quantitative trading consists of trading strategies based on quantitative analysis, which rely on mathematical computations and number crunching to identify trading opportunities. Price and volume are two of the more common data inputs used in quantitative analysis as the main inputs to mathematical models.

As quantitative trading is generally used by financial institutions and hedge funds, the transactions are usually large and may involve the purchase and sale of hundreds of thousands of shares and other securities. However, quantitative trading is becoming more commonly used by individual investors.

Key Takeaways

  • Quantitative trading utilizes mathematical functions and automated trading models to make trading decisions.
  • In this type of trading, backtested data are applied to various scenarios to help identify opportunities for profit.
  • The advantage of quantitative trading is that it allows for optimal use of available data and eliminates the emotional decision-making that can occur during trading.
  • A disadvantage of quantitative trading is that it has limited use: a quantitative trading strategy loses its effectiveness once other market actors learn of it, or as market conditions change.
  • High-frequency trading (HFT) is an example of quantitative trading at scale.

Understanding Quantitative Trading

Quantitative traders take advantage of modern technology, mathematics, and the availability of comprehensive databases for making rational trading decisions.

Quantitative traders take a trading technique and create a model of it using mathematics, and then they develop a computer program that applies the model to historical market data. The model is then backtested and optimized. If favorable results are achieved, the system is then implemented in real-time markets with real capital.

The way quantitative trading models function can best be described using an analogy. Consider a weather report in which the meteorologist forecasts a 90% chance of rain while the sun is shining. The meteorologist derives this counterintuitive conclusion by collecting and analyzing climate data from sensors throughout the area.

A computerized quantitative analysis reveals specific patterns in the data. When these patterns are compared to the same patterns revealed in historical climate data (backtesting), and 90 out of 100 times the result is rain, then the meteorologist can draw the conclusion with confidence—hence, the 90% forecast. Quantitative traders apply this same process to the financial market to make trading decisions.

Historical price, volume, and correlation with other assets are some of the more common data inputs used in quantitative analysis as the main inputs to mathematical models.

Examples of Quantitative Trading

Depending on the trader's research and preferences, quantitative trading algorithms can be customized to evaluate different parameters related to a stock. Consider the case of a trader who believes in momentum investing. They can choose to write a simple program that picks out the winners during an upward momentum in the markets. During the next market upturn, the program will buy those stocks.

This is a fairly simple example of quantitative trading. Typically an assortment of parameters, from technical analysis to value stocks to fundamental analysis, is used to pick out a complex mix of stocks designed to maximize profits. These parameters are programmed into a trading system to take advantage of market movements.

Quantitative trading techniques are utilized extensively by certain hedge funds, high-frequency trading (HFT) firms, algorithmic trading platforms, and statistical arbitrage desks. These techniques may involve rapid-fire order execution and typically have short-term investment horizons.

Advantages and Disadvantages of Quantitative Trading

The objective of trading is to calculate the optimal probability of executing a profitable trade. A typical trader can effectively monitor, analyze and make trading decisions on a limited number of securities before the amount of incoming data overwhelms the decision-making process. The use of quantitative trading techniques illuminates this limit by using computers to automate the monitoring, analyzing, and trading decisions.

Overcoming emotion is one of the most pervasive problems with trading. Be it fear or greed, when trading, emotion serves only to stifle rational thinking, which usually leads to losses. Computers and mathematics do not possess emotions, so quantitative trading eliminates this problem.

Quantitative trading does have its problems. Financial markets are some of the most dynamic entities that exist. Therefore, quantitative trading models must be as dynamic to be consistently successful. Many quantitative traders develop models that are temporarily profitable for the market condition for which they were developed, but they ultimately fail when market conditions change.

Frequently Asked Questions

Do quant traders make a lot of money?

Because they must possess a certain level of mathematical skill, training, and knowledge, quant traders are often in demand on Wall St. Indeed, many quants have advanced degrees in fields like applied statistics, computer science, or mathematical modeling. As a result, successful quants can earn a great deal of money, especially if they are employed by a successful hedge fund or trading firm.

What is a quantitative trader?

Quantitative traders, or quants for short, use mathematical models and large data sets to identify trading opportunities and buy and sell securities.

How do I become a quant?

An aspiring quant trader needs to be exceptionally skilled and interested in all things mathematical. A bachelor's degree in math, a master's degree in financial engineering or quantitative financial modeling, or an MBA are all helpful for scoring a job; many analysts will also have a Ph.D. in these or similar fields. In addition to an advanced degree, a quant should also have experience and familiarity with data mining, research methods, statistical analysis, and automated trading systems.

What is the difference between algorithmic and quantitative trading?

The primary difference is that algorithmic trading is able to automate trading decisions and executions. While a human can be a quant, computers are much faster and more accurate than even the most dexterous trader.

Where can I learn algorithmic or quantitative trading for free?

Because quant trading requires a mastery of math, statistics, and programming, it is unlikely to be the case that one can simply read a few books and become adept. Rather, successful quants invest a great deal of time and money in formal education, industry credentialing, and self-study. Additionally, the cost of the trading systems and infrastructure to begin trading as a quant are high and capital-intensive.