Inside the Black Box: A Simple Guide to Quantitative and High Frequency Trading, 2nd Edition

CHAPTER 2

An Introduction to Quantitative Trading

You see, wire telegraph is a kind of a very, very long cat. You pull his tail in New York and his head is meowing in Los Angeles. Do you understand this? And radio operates exactly the same way: You send signals here, they receive them there. The only difference is that there is no cat.

—Attributed to Albert Einstein, when asked to explain the radio

The term black box conjures up images of a Rube Goldberg device in which some simple input is rigorously tortured to arrive at a mysterious and distant output. Webster's Third New International Dictionary defines a Rube Goldberg device as “accomplishing by extremely complex roundabout means what actually or seemingly could be done simply.” Many observers in both the press and industry use markedly similar terms to describe quants. One Washington Post article, “For Wall Street's Math Brains, Miscalculations; Complex Formulas Used by ‘Quant' Funds Didn't Add Up in Market Downturn,” contains the following definition: “A quant fund is a hedge fund that relies on complex and sophisticated mathematical algorithms to search for anomalies and non-obvious patterns in the markets.”1 In the New York Post's “Not So Smart Now,” we learn that “Quant funds run computer programs that buy and sell hundreds and sometimes thousands of stocks simultaneously based on complex mathematical ratios. . . .”2 Perhaps most revealing, this view is held even by some of the world's best-respected investors. David ...