I am beginning this thread, at the request of Donald, as a globally moderated thread. The reason is to share my learning on various quantitative (quant) systems with VP members and also share actionable ideas from some of my quant systems from time to time.
Members can ask questions or make comments which will be visible only after it is approved. This is opposite to what the normal flow is in other regular threads in VP. The objective is to keep the thread clutter-free and to-the-point.
AN INTRODUCTION TO QUANT
Any method of investing (or trading) which is solely dependent on numerical methods is a quantitative system.
There are many misconceptions and a general ignorance of quant systems. For most people, it means high-frequency trading as was made famous by Michael Lewis’ book Flash Boys.
However, even the Nifty, Sensex or any index, for that matter, is a quant system. So, people who are proponents of passive index-based investing are actually (unknowingly) investing in a quant-based system.
Another famous example of a quant system is Joel Greenblatt’s Magic Formula which uses return on capital and earnings yield.
What is NOT a quant system?
Another misconception with people is that they equate quant systems with systems based on technical analysis. While there is a lot of statistical and mathematical analysis used in technicals, its bedrock is that of chart reading. That is a subjective study and is NOT quantifiable. One tech analyst’s cup & handle pattern may differ from another’s.
However, indicators like moving averages, oscillators are extensively used in quant systems.
Advantages of using quant systems
- The biggest advantage is that it completely eliminates human behavioral biases, which according to me, is the most critical factor in investing success.
- Strategies can be backtested and stress-tested to check how they had or would have performed under different circumstances. For example, you can see how your strategy would have performed in the crash of 2008 or Mar 2020.
- You can pick and choose the type and timeframe of systems you invest in. There are short term (1-day) or long term ( multi-year) systems that are operational. Personally, I tend to use monthly and quarterly reset systems.
- You are ideally NOT investing in 1-2 stocks but a portfolio of stocks, usually between 5 to 50, so you are reasonably well diversified.
- All systems have exit plans, so the usually the worst-case scenario is well covered.
- Once a system is developed, it requires very little time to implement and execute it. For a monthly strategy, it hardly takes 10 mins a month to do the actual transactions, assuming that it is also not automated.
- A combination of multiple strategies of different styles works extremely well across market cycles.
Disadvantages of using quant systems
- You do not know the details about all the stocks thrown up by the system, so the conviction is NOT on individual stocks.
How can YOU use a quant system?
- Style diversification. Every investor is comfortable in a particular style of investing. Some like value investing, some momentum, some GARP, etc. You can pick a contrasting quant style and deploy a part of your portfolio so that your portfolio has what I call “style-diversification”.
For example, I primarily like compounders & GARP stocks and am not very good with momentum or short term trades. So, I invest in a couple of quant strategies which are pure growth and momentum-based.
- Works very well as an idea generation method. Further study / due diligence can be done on stocks selected by a quant system.