Inside the Black Box: The Simple Truth About Quantitative Trading

Chapter 7. Execution

Quality is never an accident; it is always the result of high intention, sincere effort, intelligent direction and skillful execution.

—William A. Foster

So far in our tour through the black box, we have seen how quants determine what portfolio they want to own. Quants build alpha models, risk models, and transaction cost models. These modules are fed into a portfolio construction model, which determines a target portfolio. But having a target portfolio on a piece of paper or computer screen is considerably different than actually owning that portfolio. The final part of the black box itself is to implement the portfolio decisions made by the portfolio construction model.

There are two basic ways to execute a trade: The first is electronic, the second is through a human intermediary (e.g., a broker). Most quants elect to utilize the electronic method, because the number of transactions is frequently so large that it would be unreasonable and unnecessary to expect people to succeed at it. Electronic execution is accomplished through direct market access (DMA), which allows traders to utilize the infrastructure and exchange connectivity of their brokerage firms to trade directly on electronic markets such as ECNs.

Several points bear clarification. First, DMA is available to any trader, whether quant or discretionary, and in fact, many discretionary traders also utilize DMA platforms offered by their brokers to execute trades. Trades submitted via DMA can still ...