The question of quantitative analysis and quantitative investing popped up in the ongoing debate about the executive options scandal. While avoid the tag of “technician” Barry Ritholtz admits that his approach to the markets is quantitative. As the capital markets have matured we think it is safe to say that quantitative approaches and techniques have become all the more important. For example in a prior post we discussed the attractiveness of quantitatively managed mutual funds.
This point was driven home in an informative post by Brett Steenbarger at TraderFeed. We think it is safe to call Dr. Steenbarger an expert on trading psychology and the taxonomy of traders. In his experience there are two different kinds of traders: technicians and quants. They have different approaches to the market and deal with different kinds of psychological challenges. What we found interesting was this:
At many investment banks and hedge funds, however, visual trading is practically non-existent. If you don’t have a model with a demonstrable edge, you don’t trade. Such traders tend to have solid analytical strengths, but are not necessarily risk-takers.
Traditional visual traders have been swept from wide swaths of the professional trading arena. The quantitatively driven traders are seemingly ascendant. If one thinks about the nature of proprietary desks in investment banks and hedge funds they are not only seeking profits, but consistent profits. In contrast, pure trend followers tend to have much lumpier return patterns. In short, if you are trading without a viable, well-tested plan or methodology then it might be time to re-think your approach. Flying by the seat of your pants isn’t going to cut it.
This question of quantitative modeling was also raised in an excellent post over at CXO Advisory Group. In it they highlight an article on the applicability of genetic programming techniques to stock selection. Not surprisingly the authors of the study find that these tools can generate risk adjusted outperformance. While the findings themselves are interesting, this cautionary note from CXO caught our eye:
One thing this paper reinforces is that individual stock-picking investors are competing with very sophisticated, well-funded institutional “quants” (quantitative financial analysts) for excess returns. Perhaps this daunting competition is suppressing stock picking overall…
The point of this post is not to endorse a particular investment method, but should serve rather as a cautionary tale. Clearly there successful traders who utilize different techniques. However, the capital markets, especially the stock market, is teeming with sophisticated investors armed with well-defined plans and advanced tools. Individual investors choosing to play this game need to realize that they are going up against formidable competition.