Inside the Black Box: The Simple Truth About Quantitative Trading

1.1. THE BENEFIT OF DEEP THOUGHT

According to James Simons, the founder of the legendary Renaissance Technologies, one of the greatest advantages quants bring to the investment process is their systematic approach to problem solving. As Dr. Simons puts it, "The advantage scientists bring into the game is less their mathematical or computational skills than their ability to think scientifically."^[]

The first reason it is useful to study quants is that they are forced to think deeply about many aspects of their strategy that are taken for granted by nonquant investors. Why does this happen? Computers are obviously powerful tools, but without absolutely precise instruction, they can achieve nothing. So, to make a computer implement a "black-box trading strategy" requires an enormous amount of effort on the part of the developer. You can't tell a computer to "find cheap stocks." You have to specify what find means, what cheap means, and what stocks are. For example, finding might involve searching a database with information about stocks and then ranking the stocks within a market sector (based on some classification of stocks into sectors). Cheap might mean P/E ratios, though one must specify both the metric of cheapness and what level will be considered cheap. As such, the quant can build his system so that cheapness is indicated by a 10 P/E or by those P/Es that rank in the bottom decile of those in their sector. And stocks, the universe of the model, might be all U.S. stocks, ...