Quantitative trading doesn’t need to mean complicated machinations with Python and R and stuff Albert Einstein might write on a chalkboard. It can be simple math reflecting how the stock market works.
For example, back in November I bought three positions in the last ten minutes of market hours. Longtime readers of our Market Structure EDGE daily notes (find EDGE in the Discover section at IBKR), know I prefer buying late in the day, selling the next day. It’s not the only way to trade and I routinely do otherwise. But if you’re stressed by trading, don’t have a lot of time, it’s a solution.
It works often because roughly 50% of volume in the S&P 500 at any given time is “Fast Trading,” computerized order flow with a horizon of a day or less. I learned that description, by the way, from a high-frequency trader, who described his firm’s strategy as “an investment horizon of a day or less.”
Genius, right? If you have great data, and fast machines, you just run in front of everybody all day long. Then you exit right before the close – like an off-ramp – and start over the next day. Now, you need an advantage of course. Like Citadel. Two Sigma. Quantlab. Tower Research. Jane Street. Susquehanna. GTS. Optiver. Hudson River Trading.
And so on. Never heard of most of those? They don’t have customers, that’s why. They trade their own money. Proprietary trading, it’s called.
I’ve told veteran EDGE users this story. My first quantitative analytics firm, ModernIR.com, was running market data in roughly 2007 for Intel, a customer then (not today). We were measuring the firms executing trades. Goldman Sachs had a big portion of trading volume (trades for hedge funds).
Then this outfit calling itself “Octeg” showed up. Suddenly they were doing twice the volume that Goldman Sachs was. We thought, “What the heck? Who is this?” We’d never seen this firm!
So we rooted through regulatory filings for MPIDs – Market Participant Identifiers. Go search “MPID” with Google, Duck Duck Go, some AI engine. You’ll see.
And we found Octeg and another firm with the same Chicago mailing address calling itself the Global Electronic Trading Company. GETCO. Put that name in front of a mirror. You get Octeg.
And the mystery was solved.
It was one of the first big “high-frequency traders” after the implementation of Regulation National Market System (it subsequently bought Knight Trading – customer of ours too – when it had a disastrous trade, and you can look that up, and that combo was in turn bought by Virtu, good friends of ours).
Reg NMS automated trades, requiring that all stocks trade between the best bid to buy or offer to sell and mandating that any of those “marketable trades” be automated. In response to rule-changes, exchanges started paying for bids and offers – the so-called “maker-taker” market where buying is taking, selling is making.
And guess which price is always better? Selling. The offer!
Well. Humans are smart. Somebodies got in a conference room and said “why don’t we build machines that race ahead and sell to people, and then buy from them a penny lower?”
And high-frequency trading was born. We called it “coupon-cashing.” You just sell stuff at exchanges and get paid for it. It became 75% of the stock market in 2008-9. I’m not kidding you.
Then everybody including Goldman Sachs caught up technologically and got fast too, and today it’s about half the volume.
You with me still? Half the trading volume, give or take, is machines racing ahead just for the day. That volume starts over every day. And there’s your advantage in being just a DAY longer. They start at zero. Go. You didn’t. You started the day before.
Got it?
So I bought – actually I bought it, sold it, and bought it again, because I made 25 basis points in one minute – a leveraged volatility ETF (you can find these). I bought about 700 shares of it the second time. And I bought 799 shares of a SHORT S&P 500 leveraged ETF, and 60 shares of LONG leveraged S&P 500 ETF.
I used MATH to bet short. Broad Sentiment – a measure you can see via Daily Trading Ideas (click through a stock and choose “Broad Market” – was peaked at 6.9. A topped market tends to stall or fall – boosting volatility.
By the way, as I write on Dec 6, Broad Sentiment is AGAIN 6.9. And I’m again using a volatility bet (because volatility has vanished and the math says it may return).
What if I’d been wrong? The market is NOT a metronome. It’s a central tendency, just like human nature. It might go up today, even if the central tendency is down. So I hedged with those 60 long shares. What I was really trying to do was to profit on VOLATILITY.
And guess what else? Volatility options expired the next day (Nov 20).
It worked. Doesn’t every time. This is quantitative trading using simple math reflecting Demand and Supply in the market. Because volatility options expire tomorrow, Wednesday.
I was able to construct that cagey bet by understanding MARKET STRUCTURE. The math, mechanics, and rules of the stock market. The market is not fundamental. It’s 100% electronic, 98% algorithmic. It runs on math – and math is calculable, unlike human nature.
To be a good quant trader, you need to know market structure, like Citadel et al. (Join my next IBKR Campus Webinar Dec 16 to learn more!).
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