Trading Education, Trading Tools

Does Quantitative Trading really Work?

Case studies - day trading

A common question many traders ask is, “does quantitative trading really work?”. To better answer this question we will first define quantitative trading and discuss the many benefits to this type of trading strategy as well as some complications. 

What is Quantitative Trading?

Quantitative trading is a strategy that uses mathematical analyses to identify trading opportunities. These mathematical analyses use a variety of inputs such as price and volume to determine profitable investments. In other words, these mathematical models and strategies can tell the traders when to buy and sell securities. Quantitative strategies generally start with very simple models and gradually tweak and expand the inputs with continued research and backtesting. Quantitative trading is most commonly used by large financial institutions to process very large volumes, but are increasingly being used by retail traders. The majority of quantitative trading strategies rely on short-term positions. Additionally, quantitative trading often uses technology to create these mathematical models for analysis. Let’s now look into some of the benefits from quantitative trading.

What are the Benefits of Quantitative Trading?

One of the main benefits from quantitative trading is that it optimizes profits by identifying trading opportunities and allows large scalability for financial institutions. These institutions handle such large sums of money that the consequences of a human trader misclicking or mistyping something can be catastrophic. Furthermore, the costs of employing human traders on such a large scale diminishes profitability. Using these mathematical models combined with technology has allowed institutions to execute high volumes of trades with reduced human risks and costs.

Utilizing a mathematical model to recognize trading opportunities also allows for unemotional trading and reduces any human biases through its disciplined nature. Another benefit of quantitative trading is its ability to be backtested. Since this strategy uses mathematical analyses, it is actually tested using historical market data to help determine if the strategy will be profitable in the future. Lastly, these mathematical models can continuously monitor the market in a manner unachievable by humans.

Are there any Disadvantages to Quantitative Trading?

While there are numerous advantages to quantitative trading, it is also important to keep in mind the disadvantages before you start making a quantitative trading strategy. Something to consider before shifting to quantitative trading is the time commitment. Quantitative trading strategies could take years to develop as they require substantial research and backtesting before determining if it is profitable. Additionally, something to consider with any trading strategy is that the markets are continuously changing. At some point the strategy will no longer be profitable and will have to be modified.

Finally, without human supervision, a modeling error can create deep losses. That is, although institutions have the resources to perfect their models, retail traders are unlikely to have the quality control personnel and technology necessary to safely implement quantitative strategies without risk. To mitigate the risk of model failure, retail traders may consider utilizing quantitative models that instruct when to trade but do not actually conduct the trades. This will prevent improper coding or other technical glitches from generating extreme losses. These few disadvantages to quantitative trading should be considered before you start, but overall the benefits may outweigh the drawbacks in the long run.

The Final Consensus on Quants

Finally, to answer the question “does quantitative trading really work?”, we should consider the numerous benefits that this strategy offers compared to conventional trading. Discretionary trading can be very emotional as the trader is making the trading decisions, but quantitative trading helps eliminate the emotional aspects. Keep in mind that quantitative trading strategies lose effectiveness as market conditions change, so frequent testing is required to determine when to update your strategy. However, when done right, quantitative strategies have numerous advantages relative to human trading. Unfortunately, many people fail trying to create profitable quantitative trading strategies as they tend to give up too easily. Just like conventional trading, quantitative trading takes a lot of time and hard work, but it can definitely pay off in the long run. 

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