CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

37.1 VARIATIONS OF QUANTITATIVE STRATEGIES

At the heart of every equity market neutral strategy is the attempt to establish long positions in securities when their expected returns are relatively high and to establish short positions in securities when their expected returns are relatively low. Quantitative equity market neutral strategies can be divided based on underlying information (technical factors vs. fundamental factors) or trading frequencies.

37.1.1 Quantitative Strategies Focused on Technical Analysis

Quantitative equity market neutral strategies trade equities in a systematic fashion. Common techniques are based on sorting stocks given a particular indicator. The underlying indicator may be based purely on past prices and volume (i.e., technical analysis). An example would be the identification of a pairs trade between two stocks that have a high long-term correlation but recently experienced a sharp diversion in returns, widening the spread between the prices of the two stocks. A typical trading decision would be to establish a long position in the stock that had recently underperformed and a short position in the stock that had recently outperformed. The motivation for the trade would be the expectation that the stocks would converge to similar valuation levels based on their observed tendency to share similar returns and valuation levels. The trader would be speculating that the divergence in returns was temporary, perhaps based on the execution of a large order. ...