By Nicholas Vardy Russia’s Gary Kasparov was the world’s No. 1 chess player for almost 20 years.
He is best known in the U.S. for losing a chess match to IBM’s supercomputer Deep Blue in 1997.
In his book Deep Thinking: Where Machine Intelligence Ends and Human Creativity Begins Kasparov concedes that human chess players don’t have a prayer against today’s powerful computers.
Why is that?
Computers don’t get tired. They don’t get moody. They don’t make mistakes.
They are never “off their game.”
Meanwhile, a human chess player has to screw up only once to lose a match.
The same reasoning applies to trading the financial markets…
Emotions are a trader’s worst enemy.
In contrast, quantitative (or quant) based algorithms are immune to both a trader’s and Mr. Market’s mood swings.
So the question arises: “Is quant investing destined to take over the investment world?”
Rise of the Quants
The biggest quant investing firms like Renaissance Technologies, Two Sigma Investments and D.E. Shaw Group today manage tens of billions of dollars. In total, quant-focused hedge funds manage almost $1 trillion in assets.
Throw in the newer breed of exchange-traded funds and mutual funds, and that number rises to $1.5 trillion.
When I started my investment career in the 1990s, quant investing was about identifying momentum in stocks, riding trending prices like a surfer rides a wave.
I developed my first profitable momentum-based trading system in 1994 using a now defunct computer program named “Windows on Wall Street.”
Today, cutting-edge quant hedge funds use artificial intelligence (AI) and machine learning.
This kind of trading requires more the skills of astrophysics PhDs than those of traditional financial analysts.
Over the past decade, this quant-driven approach to trading has exploded.
That’s partially because any edge stemming from fundamental research has all but disappeared.
In 1815, Baron Nathan de Rothschild boasted that he used carrier pigeons to learn about the outcome of the Battle of Waterloo ahead of other investors – and thereby made a fortune.
George Soros attributed his early success investing in European companies in the 1960s to being a “one-eyed king among the blind.”
Today, financial traders have more information on their smartphones than what the world’s top hedge funds did 20 years ago.
Being a one-eyed king just doesn’t cut it anymore.
Old-Style Hedge Funds Go Quant
Hedge fund manager Paul Tudor Jones’ trading skills were enough to catapult him into the Forbes 400.
Yet his Tudor Investment Corporation has fallen on hard times, and his firm’s returns have tumbled since 2008.
In 2016, Tudor Jones began to hire quantitative analysts to kick-start his firm’s lagging performance.
What is Tudor Jones’ new philosophy?
“No man is better than a machine, and no machine is better than a man with a machine.”
Hedge fund billionaire Steven A. Cohen calls this the “man plus machine” approach.
Here’s why I think this approach makes sense.
First, taken to the extreme, quant-driven strategies sometimes identify mathematical relationships that simply make no sense.
In a paper published more than 20 years ago, quant-investment managers David Leinweber and David Krider highlighted the absurd correlation between the butter production of Bangladesh and the returns of the …read more
Source:: Investment You
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