QUANTITATIVE TRADING STRATEGIES

THE RECENT EXPLOSION OF QUANTITATIVE TRADING
The proliferation of modern quantitative trading began with a handful of futures
traders in the 1970s. Armed with IBM mainframes and punch cards, these traders
10 PART 1 Structural Foundations for Improving Technical Trading
began to test simplistic strategies on historical market data. The high leverage and
low transaction costs made futures markets a perfect match for this new breed of
trader.
Nowadays, quantitative trading is completely accepted and practiced by
many large professional commodity money managers. CTAs such as John Henry
and Jerry Parker of Chesapeake Capital manage over a billion dollars each using
trading systems to place bets on markets spanning the globe. A recent survey
found that over 75 percent of CTAs use trading systems. In fact, Jack Schwager,
author of the critically praised books Market Wizards and New Market Wizards, has
managed institutions’ funds using trading systems applied to commodity markets.
It was not until the mid-1970s that two changes in the market made quantitative
trading feasible for equities: the end of regulated commissions, and the
introduction of the Designated Order Turnaround system (DOT).
Until 1975, the New York Stock Exchange fixed the minimum commission
of stock trading. According to Robert Schwartz, a finance professor at the Zicklin
School of Business, rates for typical large institutional orders during the era of
fixed commissions was about 0.57 percent of principal. If I traded 50,000 shares
of a $50 stock, this would amount to $0.29 per share in commission costs. These
extraodinarily high costs hindered quantitative traders from entering the equity
markets.
Although lower transaction costs after the elimination of the fixed commission
structure pushed stocks closer to the realm of quantitative traders, it was the
creation of the DOT in 1976 that truly opened the equity markets. Prior to the
DOT, all orders were required to be delivered to the specialist on the NYSE via a
floor broker—both a timely and costly procedure. With the introduction of the
DOT—and subsequent upgrades such as the SuperDOT—orders of virtually any
size may now be delivered electronically and virtually instantaneously to the floor
of the NYSE.