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Quantitative Trading : How to Build Your Own Algorithmic Trading Business by Ernest P. Chan

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Chapter 7. Special Topics in Quantitative Trading

The first six chapters of this book covered most of the basic knowledge needed to research, develop, and execute your own quantitative strategy. This chapter explains important themes in quantitative trading in more detail. These themes form the bases of statistical arbitrage trading, and most quantitative traders are conversant in some if not most of these topics. They are also very helpful in informing our intuition about trading.

I will describe the two basic categories of trading strategies: mean-reverting versus momentum strategies. Periods of mean-reverting and trending behaviors are examples of what some traders call regimes, and the switch between different regimes is a topic of discussion here. Mean-reverting strategies derive their mathematical justification from the concepts of stationarity and cointegration of time series, which I will cover next. Then I will describe a theory that many hedge funds use to manage large portfolios and one that has caused much turmoil in their performances: namely, factor models. Other categories of strategies that traders frequently discuss are seasonal trading and high-frequency strategies. All trading strategies require a way to exit their positions; I will describe the different logical ways to do this. Finally, I ponder the question of how to best enhance the returns of a strategy: through higher leverage or trading higher-beta stocks?

MEAN-REVERTING VERSUS MOMENTUM STRATEGIES

Trading ...

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