What Quants Know and What Traders Refuse to Believe

2008 will be the tenth, and perhaps final year that I will be on the internet.
You see, there is simply no money to be made talking and writing about trading unless one is a professional salesperson hyping a service or a product to traders and investors who ought to know better.

Money is made when one actually engages in the activity. I need to allocate more time to reading academic papers, to think and to perform research and development.
Much of what is written about trading and investing is untrue. And in case this is it, I think the most productive use of my time blogging this year would be to do my best to help readers cut through the crap and come to some sort of program that works for the long run.

Yes, Paul Wilmott Owns Index Funds

Paul Wilmott is a quant’s quant. He wrote the book on quantitative finance.


Somewhere in the 3 volume set, Paul Wilmott on Quantitative Finance, he stated that most of his personal money is invested in…index funds.
Gasp, you say! The man who can derive Black-Scholes 10 ways can’t trade? Well, that is not exactly the case. He can trade well, but as a quant, he knows that that the market is nearly impossible to beat over the long run.
Many mainstream traders are going to object to these statements, but before anyone freaks out, please acknowledge that discussions must be nuanced: the key is the term risk-adjusted returns.
In the short run, traders can take some big risks and get lucky, but they are certain to go belly up in much less time than they ever thought possible.
So the next time you see an ad that promises to double your money, or tries to lure you into trading FOREX with 1:100 leverage, remember these are vendors who will stop at nothing to exploit your hopes and dreams. The trader who thinks making 10% a month is actually an achieveable goal on a risk-adjusted basis is someone who needs to look for a real job, and soon.

Harry Kat: The Easiest Way to Make Money for Clients is to Lower Fees

FundCreator quant Harry Kat was the subject of an excellent piece called Hedge Clipping:

  • “You might be asking for something it is just impossible to pull off,” Kat said. “I get e-mails every week from people saying, ‘Harry, can you make a twenty-five-per-cent average return with no volatility?’ Of course I can’t. The interest rate on Treasury bonds is five per cent. That is what I can achieve without any volatility.”
  • “You can be fortunate,” he said. “You can live off market trends for quite a while. As in credit spreads” — the difference in yields between different types of bonds. “Credit spreads start to come down, and you make lots of money in credit. A couple of guys from an investment bank’s credit desk jump out and start a fund. If they are lucky, the trend continues for another couple of years, and they will look like masters of the universe. But when the trend reverses, or when there is no trend left, they are in trouble. If a guy has done well for two years, what does that mean? He could be really smart, or he could be really lucky.
  • Renaissance has reportedly produced even higher returns. (Most of the top-performing hedge funds are closed to new investors.) Kat questioned whether such firms, which trade in huge volumes on a daily basis, ought to be categorized as hedge funds at all. “Basically, they are the largest market-making firms in the world, but they call themselves hedge funds because it sells better,” Kat said. “The average horizon on a trade for these guys is something like five seconds. They earn the spread. It’s very smart, but their skill is in technology. It’s in sucking up tick-by-tick data, processing all those data, and converting them into second-by-second positions in thousands of spreads worldwide. It’s just algorithmic market-making.”
  • Almost by definition, there can be only a handful of genius investors, Kat continued. “And even if they are there, the chances that you will find them and that they will let you in are very, very slim,” he said. “That’s what I tell people. If you are really convinced that you can find those super managers, then don’t waste your time with our stuff. Go look for them. But if you are a bit more realistic, if you know that eighty per cent of hedge-fund managers aren’t worth the fees they charge, then the rational thing to do is to give up trying to find a super manager, and just go for a good, efficient diversifier instead.”

So 2008 will be the year of telling it like it is. There are no scared cows, and it will certainly get ugly.