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Quantitative Trading: Financial Darkhorse of Wall Street

Wall Street
Wall Street
Mathew Knott

Quantitative trading is probably something you have not heard before. If you have, it is probably as mysterious as anything to you. Quantitative trading is done by some of the wealthiest, smartest, and most powerful people in the world. In fact, quantitative trading has the ability to take down companies, markets, and even economies. However it seems as if no one has much of a perception of what it is, much less its magnitude of colossal proportions. There have been experiences where algorithms cause crises in the markets, almost causing nations to falter. However, there have also been cases of people changing their lives by making millions of dollars in capital from quantitative trading. With the inconsistency of a relatively new sector, questions are beginning to be raised. Quantitative trading, computerized stock trading by banks and individuals whilst removing the necessity for intuitive trading raises the question, are we as a society aware of it’s susceptible magnitude?

Why do traders prefer quantitative trading as opposed to intuitive trading? Stock brokers used to make trades based off data variables such as statistics, sentiment, and experience. However, as technology has advanced, so has the way that stock brokers analyze data. Quantitative trading consists of “trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify trading opportunities. (Investopedia)” Algorithms can analyze sentiment and statistics quicker than one can even imagine. For example, stock brokers can hire someone that will present them data on a stock. However, algorithms could present that same data in a blink of an eye. Not only will the algorithm provide the information, the stock broker could even program the algorithm to complete a trade for him or her if the information sufficed. The motives behind quantitative trading are almost unimaginable. For a sector dominated by the speed and accuracy of data analysis, it now has the opportunity to be done at never before seen rates by computers. The benefits are, without question, worth it. A job that used to be done by statistics, sentiment, and experience analyzed by human hands. An algorithm can do it quicker and better.

Quantitative trading is done primarily by two different and distinct sectors. First, some of the strongest banks and firms on Wall Street and around the country are backed by billions of dollars in capital to fund algorithms to complete their stock trades. It is reported that approximately eighty-four percent of all trades on the stock market are completed by algorithms (Washingtons Blog). Now when you think about the magnitude, most of our financial economy is handled strictly by algorithms that people code. Which means that the susceptibility of the entire economy is merely at the hands of lines of code which might raise some concern. The competition of banks with their algorithms has reached unimaginable terms. For example, banks are buying real estate within the New York Stock Exchange (NYSE) just so they can be closer to the computers that feed data to their algorithms. Even though banks make up the large sum of stocks traded, day traders still have an impact on the market. Contrary to popular belief, when you consider any person who does not work for a bank talking about investing in stocks with their own capital, they only make up a small minority (approximately sixteen percent) of the trades done on the stock market. However, there is a new sector of quantitative traders rising from the mist. These people are motivated, independent programmers who want to take stock trading into their own hands. There are testimonials of programmers who coded their own algorithms and have subsequently obtained large sums of capital. This market of independent quantitative traders only makes up a small number of trades done on the market as competing with banks is highly difficult and the expertise is in low supply. Quantitative trading is done primarily by banks, and a new market is being fostered of independent traders that could change the name of the game in stock trading.

There are some critics of quantitative trading. Approximately eighty-four percent of trades done on the stock market are completed by algorithms. The majority of transactions completed on the stock market will not be seen by the eyes of humans, let alone receive any human input. The competition of the banks between their algorithms fight for trades; counteracting each other in just microseconds. For example, Goldman Sachs may complete a transaction for 700 stocks in a company in five microseconds. Merrill Lynch, another bank that uses algorithmic trading, can counteract that trade by purchasing 1,500 stocks of that same company seven microseconds later. Two banks counteracting trades of tens of thousands of dollars is completed quicker than you can blink your eyes. So thats what brings up the biggest concern of critics, the sustainability. Thus far, the stock market has not experienced an armageddon of algorithms counteracting each other causing a market failure. Unfortunately, there have been close calls. Algorithms, especially algorithms coded by different people are very susceptible to failure because of loopholes and loose ends. On May 6th, 2010, the Dow Jones suffered a 1,000 point loss in five minutes (Korn). At that time, approximately five percent of the entire market was lost into thin air thus causing a panic worldwide. Another example was in the summer of 2013. The Associated Press released a report stating that a bomb had exploded in the White House, and since many of these algorithms analyze articles (sentiment analysis), these algorithms sold stock as quick as possible thus triggering a micro-crash. The algorithms that are used to trade on the stock market are backed tested thousands and thousands of times against historical stock market data to ensure situations like these do not happen. As we transition into the technical age, we cannot get caught up in the benefits of technology but rather must focus on the susceptibility of the systems we have created.

Quantitative trading is just one of the sectors of a whole industry being created from the analysis of multi-variables. Some of the world’s most powerful people trade on the stock market through the use of algorithms. Entire economies rely on, are backed by, or even function on the use of quantitative trading and algorithms. In a world where we are just entering the technical age, big banks and individuals have a chance to truly make a name for themselves through quantitative trading. There is a veil over the idea of quantitative trading, we must begin to remove it.