Inside the Black Box: The Simple Truth About Quantitative Trading

2.3. SUMMARY

Quants are perhaps not so mysterious as is generally supposed. They tend to start with ideas that any reasonable observer of the markets might also have, but rather than using anecdotal, experiential evidence—or worse, simply assuming that these ideas are true—quants use market data to feed a research process to determine whether their ideas in fact hold true over time. Once they have arrived at a satisfactory strategy, they build their strategy into a quant system. These systems take the emotion out of investing and instead impose a disciplined implementation of the idea that was tested. But this should not be read as minimizing the importance of human beings in the quant trading process. They come up with ideas, test strategies, and decide which ones to use, what kinds of instruments to trade, at what speed, and so on. Humans also tend to control a "panic button," which allows them to reduce risk if they determine that markets are behaving in some way that is outside the scope of their models' capabilities.

Quant strategies are widely ignored by investors as being opaque and incomprehensible. Even those who do focus on this niche tend to spend most of their time understanding the core of the strategy, its alpha model. But we contend that there are many other parts of the quant trading process that deserve to be understood and evaluated. Transaction cost models help determine the correct turnover rate for a strategy and risk models help keep the strategy from betting ...