Chasing the Same Signals: How Black-Box Trading Influences Stock Markets from Wall Street to Shanghai

Chapter 11. An Adaptive Industry

What Signals Will They Be Chasing Next?

Successful quantitative firms are not simply founded on their knowledge of mathematics and physics. They are equally founded on the innovation and creativity of their people. Longevity, for a black-box firm, is rooted in its ability to extract the best ideas from their people and to continuously adapt to an increasingly competitive market place.

Perhaps more so than any other investment strategy, black-box trading is subject to tough economic challenges. They find that maintaining an edge on execution is an ongoing arms race of technology. They experience that subtle changes in the regulatory environment can dramatically alter the profit opportunities of their models. They learn of competitors, targeting similar price anomalies and crowding their margins.

The longevity of black-box strategies is unlike that of any other investment strategy as well. They prosper in unique economic conditions, defined by volatility, dispersion, serial correlation, or spreads. Their businesses do not benefit from the overall prosperity of the economy, when the rising tide lifts all boats.

As David Kabiller, one of the founding partners of AQR Capital, described it:^[59]

You sow the seeds of your own destruction by too many people embracing it—that's why we think that a lot of the best strategies out there have finite capacity to them, because the more money that's attracted to them, the more likely that over time they'll be degraded. ...