Quantitative Trading

CHAPTER 1 The Whats, Whos, and Whys of Quantitative

Trading 1

Who Can Become a Quantitative Trader? 2

The Business Case for Quantitative Trading 4

Scalability 5

Demand on Time 5

The Nonnecessity of Marketing 7

The Way Forward 8

CHAPTER 2 Fishing for Ideas 9

How to Identify a Strategy That Suits You 12

Your Working Hours 12

Your Programming Skills 13

Your Trading Capital 13

Your Goal 16

A Taste for Plausible Strategies and Their Pitfalls 17

How Does It Compare with a Benchmark and How Consistent

Are Its Returns? 18

How Deep and Long Is the Drawdown? 21

How Will Transaction Costs Affect the Strategy? 22

Does the Data Suffer from Survivorship Bias? 24

How Did the Performance of the Strategy Change over the Years? 24

Does the Strategy Suffer from Data-Snooping Bias? 25

Does the Strategy “Fly under the Radar" of Institutional

Money Managers? 27

Summary 28

CHAPTER 3 Backtesting 31

Common Backtesting Platforms 32

Excel 32

MATLAB 32

TradeStation 35

High-End Backtesting Platforms 35

Finding and Using Historical Databases 36

Are the Data Split and Dividend Adjusted? 36

Are the Data Survivorship Bias Free? 40

Does Your Strategy Use High and Low Data? 42

Performance Measurement 43

Common Backtesting Pitfalls to Avoid 50

Look-Ahead Bias 51

Data-Snooping Bias 52

Transaction Costs 60

Strategy Refinement 65

Summary 66

CHAPTER 4 Setting Up Your Business 69

Business Structure: Retail or Proprietary? 69

Choosing a Brokerage or Proprietary Trading Firm 71

Physical Infrastructure 75

Summary 77

CHAPTER 5 Execution Systems 79

What an Automated Trading System Can Do for You 79

Building a Semiautomated Trading System 81

Building a Fully Automated Trading System 84

Minimizing Transaction Costs 87

Testing Your System by Paper Trading 89

Why Does Actual Performance Diverge from Expectations? 90

Summary 92

CHAPTER 6 Money and Risk Management 95

Optimal Capital Allocation and Leverage 95

Risk Management 103

Psychological Preparedness 108

Summary 111

Appendix: A Simple Derivation of the Kelly Formula when

Return Distribution Is Gaussian 112

CHAPTER 7 Special Topics in Quantitative Trading 115

Mean-Reverting versus Momentum Strategies 116

Regime Switching 119

Stationarity and Cointegration 126

Factor Models 133

What Is Your Exit Strategy? 140

Seasonal Trading Strategies 143

High-Frequency Trading Strategies 151

Is It Better to Have a High-Leverage versus

a High-Beta Portfolio? 153

Summary 154

CHAPTER 8 Conclusion: Can Independent Traders

Succeed? 157

Next Steps 161

Appendix A Quick Survey of MATLAB 163

Bibliography 169

About the Author 173

Index 175