Editor’s Note: Today’s Wealthy Retirement comes from Nicholas Vardy, Quantitative Strategist at our sister e-letter Liberty Through Wealth.
Read on to learn how quant trading got its rise on Wall Street – and how, in the age-old battle of humans versus machines, you can come out on top.
– Mable Buchanan, Managing Editor
Over the past 10 years, a battle between man and machine has been raging on Wall Street.
And today, the verdict is clear.
The machines have won.
The biggest and most liquid financial markets in the world are now traded mostly by computers with little, if any, human intervention.
In total, quant-focused hedge funds manage almost $1 trillion in assets.
Fifteen years ago, star traders who swung for the fences ruled the hedge fund roost. Today, these alpha traders have ceded control to thousands of anonymous “quants” – quantitative analysts – armed with PhDs.
Just how valuable are these secretive trading algorithms to quant funds?
Hedge fund giant Citadel recently sued one of its former employees for stealing its “ABC” trading algorithm that it had developed at a cost of $100 million.
What does all this have to do with you, the small investor?
As it turns out, thanks to the democratization of computing power…
You are in a far better position than giant quant funds to generate double- and triple-digit returns using cutting-edge quantitative strategies.
And as The Oxford Club’s Quantitative Strategist, I can show you how.
The Advantages of Quantitative Investing
Quantitative investing uses artificial intelligence and machine learning to extrapolate patterns in historical data. This approach offers two big edges.
No. 1: Computers are smarter than humans.
Investors have always sought to gain an edge.
In the 15th century, traders in Venice used telescopes to identify the flags of incoming ships, deriving clues about their cargo to buy and sell commodities.
In 1815, Nathan Mayer Rothschild is said to have used carrier pigeons to learn about the outcome of the Battle of Waterloo ahead of other investors. That edge made him a fortune.
George Soros credited his early success investing in European stocks in the 1960s to being a “one-eyed king among the blind.”
Alas, telescopes, carrier pigeons and one-eyed kings just don’t cut it anymore.
Today’s edge on Wall Street belongs to computers and quant trading systems.
Computers can parse, analyze and integrate data like no human can. They recognize profitable patterns invisible to the human eye.
Here’s a recent example…
In late 2019, quant giant Renaissance Technologies took a massive position in Tesla (Nasdaq: TSLA) right before it soared almost fourfold.
Tesla was among the most shorted stocks on Wall Street.
No analyst trained in traditional fundamental investing would have dared to place the bet Renaissance did.
But Renaissance’s algorithms knew something fundamental analysts didn’t. And it made more than $1.5 billion on that single trade.
That’s more than what George Soros made in 1992 when he famously “broke the Bank of England.” It also made Renaissance’s bet on Tesla one of the greatest trades ever.
No. 2: Computers don’t make mistakes.
Russia’s Garry 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.
Machine has beaten man many times since then.
Today, Kasparov concedes that human chess players don’t have a prayer against powerful computers.
Computers can process information at the speed of light. They don’t get tired or make mistakes.
It takes only one mistake for a human chess player to lose a match.
The same reasoning applies to human decision making versus quant algorithms in the world of investing.
Dozens of cognitive biases steer humans toward making bad decisions.
Fatigue, emotions and limited capacity to process information are implacable foes.
In contrast, quantitative algorithms aren’t human. They are immune to fear, greed or any other feeling. They are indifferent to Mr. Market’s mood swings.
That’s why investing against machines is like playing chess against a computer.
Yes, you may beat the computer occasionally. But in the long term, you’re playing a loser’s game.
The Small Investor’s Edge
Yet Wall Street’s quant funds have an Achilles’ heel.
Quant funds have gotten too big for their investment britches. They struggle with entering and exiting their positions.
But as a small investor, you can buy and sell positions with a few clicks of a mouse.
More importantly, you can play the options market. Because of its relatively small size, the options market is off-limits to big quant hedge funds.
The ability to play the options market gives you the kind of potential upside Wall Street’s big quant funds can only dream about.