What is quant trading? Readers of Michael Lewis’s Flash Boys probably think of quants as a cabal of mathematicians exploiting the stock market with proprietary algorithms. If you yourself are a quant, you might explain your trade as the application of mathematical principles to the problem of portfolio optimization.
Whether its definition is inflammatory or prosaic, quant trading is an inescapable part of today’s financial market. The hardware and software breakthroughs that allowed 1950s mathematical theorems to be applied to the late 20th century stock market created a positive feedback loop of analytic improvements and infrastructure optimization. Even as quants dialed back on high frequency trading in response to the Great Recession in the 2000s, this tech-to-theory-to-tech feedback loop kept going.
Against the backdrop of the Great Recession and the accelerating technical optimization in the financial sector, Satoshi Nakamoto published a 2008 white paper detailing a peer-to-peer transaction system that operated outside financial institutions. The resulting cryptocurrency market has been a major economic force ever since. Below, we’ll go over the history of quantitative trading, stocks, and blockchain technology, and gain insight into the emerging field of crypto quant trading.
What makes quant trading different from other trading?
Quant trading vs. algorithmic trading
A quick note on algorithmic trading: talking about algo trading versus quant trading can be misleading. In algo trading, a company uses an automated system programmed with an algorithm to execute trades. Quant traders may apply mathematical principles to develop these algorithms, and either use them in their own practices or sell them to trading companies. Machine learning quant trading could involve training neural nets to develop algorithms that can later be used in automated systems. However, it is possible to dabble in algorithm trading without learning to be a quant trader—you just need to purchase the right algorithm.
Quant trading vs. traditional trading
Traditional trading is more art than science. It requires an intimate knowledge of market trends, novel developments in industry, and current events. Hedge fund managers and bankers still make stock market trades using qualitative expertise and without input from quants.
Quant trading 101 starts the same way as traditional trading 101: by understanding the history of the stock market. Having stock in a company means that you share an interest in its profits. Even in the 14th century, Venetian moneylenders were running an analog stock market by selling individual clients’ debts to other shareholders.
Something closer to the modern stock market emerged towards the end of the 16th century. Rather than purchasing shares in the debt of an individual, people could invest as shareholders in a financial institution by purchasing promissory notes or bonds. These papers often functioned as currency. Some joint stock companies, like the Dutch East India Company, sold shares in their shipping ventures as well.
Wall Street burst onto the scene in 1792. Two dozen brokers started trading five securities on the New York Stock Exchange. Up until the 20th century, investors built portfolios by looking at stocks individually, determining whether they had good potential returns by guessing at market trends.
Then Harry Markowitz came along.
In 1952, he put forth the Modern Portfolio Theory (MPT): a mathematical formula that optimized the risk-to-reward ratio when building a diverse portfolio of stocks. The raw potential of his theory earned him a Nobel Prize, but the infrastructure to support quantitative trading on a large scale just wasn’t there yet. That came when the DOT system in the 1970s and 1980s enabled the NYSE to take electronic orders, and Bloomberg terminals put real-time data into the hands of previously theoretical quants.
At this time the United States cemented its transition to fiat money: currency backed only by its status as legal tender and whose value is tied to the nation’s economy. All over the world, representative money that could be redeemed for gold and silver was being phased out in favour of fiat. Quant trading and algo trading underwent widespread adoption in a world where money was fast becoming a computational construct.
Traditional traders need to know the markets inside and out, to understand the reasons behind financial trends, and to keep their fingers on the pulse of the business world. A quant trader just needs raw data and computing power. They can build mathematical models to analyze market fluctuations and use that information to build a diverse stock portfolio with excellent returns, or write high-frequency trading software that exploits these fluctuations for astronomical profit. With machine learning quant trading, they can train a neural net to do it for them.
Like a traditional trader, the quant trader is still trying to maximize their returns by buying and selling stocks. However, their methods are a step removed from the world of traditional stock market trading. The quant trader’s potential to disrupt the market is still not fully understood. Will quants seek exploitative short-term gains that lead to economic collapse? Or will they pioneer a new free market and trigger explosive economic growth?
The future scope of blockchain technology and quant trading
Blockchain technology backs a new currency that isn’t tied to a nation’s economy or a financial institution. Cryptocurrency is backed by computer encryption itself. As a fully digital currency, it is well-suited for the application of quant trading methods, and tokens will often incorporate quant trading into their very structure.
Predictions that blockchain technology will replace fiat money abound. While such a dramatic transition is unlikely to happen within the next few years, it’s clear that crypto is here to stay. Understanding blockchain technology security is fast becoming essential for financial service providers.
If you are looking for the best quant trading platform, researching the best blockchain technologies, or simply looking to implement these innovative investment techniques in your financial practice, you will need a secure IT infrastructure.
Hypertec has extensive knowledge and expertise in data infrastructure for financial service providers. From rack-and-stack services to support for transitioning to cloud service providers, Hypertec has the IT solutions for your crypto quant trading needs.
Get a jump on crypto market trends by setting up your IT infrastructure with Hypertec. Contact us today!