Inside the Black Box: The Simple Truth About Quantitative Trading

3.4. IMPLEMENTING THE STRATEGIES

There are not many ways for alpha-focused traders to make money, whether they are quants or not. But the limited selection of sources of alpha does not imply that all quants choose one of a handful of phenomena and then have a peer group to which they are substantively identical. There is in fact considerable diversity among alpha traders, far more so than may be evident at first glance.

This diversity stems from the way quants implement their strategies, and it is to this subject that we now turn our attention. There are many characteristics of an implementation approach that bear discussion, including the forecast target, time horizon, bet structure, investment universe, model specification, and run frequency.

3.4.1. Forecast Target

The first key component of implementation is to understand exactly what the model is trying to forecast. Models can forecast the direction, magnitude, and/or duration of a move and furthermore can include an assignment of confidence or probability for their forecasts. Many models forecast direction only, most notably the majority of trend-following strategies in futures markets. They seek to predict whether an asset price will rise or fall, and nothing more. Still others have specific forecasts of the size of a move, either in the form of an expected return or a price target. Some models, though they are far less common, also seek to identify how long a move might take. If the forecasted behavior is not exhibited ...