Curated Interviews From Quants: Algorithmic Trading and High Frequency Trading (From Reddit’s IAmA) Part 1

What is it exactly that quants do?

This is the second post in a series of curated interviews from Reddit’s IAmA subreddit, a place where individuals of various professions and backgrounds can request the community to “ask me anything”. The first post I wrote about investment bankers was well received, and I received several requests for IAmAs on other positions in the financial services industry, so I have decided to write a series of posts on quants that work with algorithmic trading and high frequency trading.

I encourage new readers to read the first post to understand my motivation for curating these interviews, but it can basically be boiled down to this: Practitioners in the financial industry generally aren’t motivated to share information with others and the ones that do are sometimes at risk of being fired by their employers. This results in significantly less robust online financial discussion when compared to other online communities.

There is also an issue of signal to noise — 95% of financial-related websites are crap because their primary purpose is to try to sell you something (usually newsletter prescriptions). Reddit’s IAmA subreddit is a surprisingly good source for quality discussion around interesting topics precisely because there are no ulterior motives (aside from accumulating “karma”) and because its done anonymously, allowing practitioners to say and explain things without the limitations that hold back most practitioners in the financial industry.

I have selected some curated questions and responses from that,  in my opinion,  comprise some of the best quant/algorithmic trading/high frequency trading interviews on Reddit. There is some good content both for novices that are being introduced to algorithmic trading and HFT for the first time, as well as developers that may wish to attempt developing some basic automated trading systems during their spare time.

IAMA (was) HFT algo programmer for a major investment bank for 10 years and currently a pro trader. AMA

  • What are the basic tricks of HFT?

HFTs do variety of things, but since their profit margin is very small, they need to be very high probability trades. Arbitrage is a big area for HFTs. When you hear about co-location and receiving quotes faster than the rest of the market, this is arbitrage. Essentially, they look for times when say AAPL is 224.25 in one market and 224.29 in another market and simultaneously buy the lower and sell the higher. When I say one market vs another this could be different exchanges, instruments (such as options), derivatives such as AAPL portion in S&P500. The second big area of HFTs is market making. If a stock is quoting bid/ask = $40/$40.20, this means a buy will be executed at $40.20 and a sell will be executed at $40. The HFT may add bid/ask = $40.10/$40.11 to the market. Note the price has improved for both buyer and seller. This increases the chances of trades taking place and the HFT profits 0.01.

  • Is it true that it is virtually impossible to profit or even make a living by retail trading?

No, its very possible to profit, make a living or be a millionaire by retail trading but its very very hard, because everyone has picked bad habits during their early investing/trading days. Many of these are reinforced by TV and web media.
For example:

  • buy and hold and everything will eventually be profitable.
  • buy a winner all the way to the top
  • buy (scale in) a loser till it becomes profitable.
  • the bull/bear market will never end, keep buying

Paul Rotter makes about $60 million a year trading. Al Brooks makes a living trading the size of small institutions. Most of these are day traders. About 80% of traders will lose everything they have. 11% will be consistently be profitable. The rest will break even. You have to trade for a while to move to the top bracket, but it can be done. I trade for a living and know quite a few people who do.

IAmA Someone who worked for Investment Banks developing automated trading systems AMA

  • If you’re capable of making a program that is obviously extremely profitable – why don’t you use it for personal stock trading and rake in money day trading or something?

It’s a team effort, the same reason a game developer at Sony doesn’t go and make their own games.

If you are using E-trade, you are just day trading. Fees per trade will be about $8. Using strategies like the ones described above involve many smallish trades. A common strategy is finding a relationship between two stocks – lets say DELL historically has been worth 1.3 times more per share than MSFT. Your strategy will then to be to buy or sell MSFT (or DELL) when one diverges from that multiplier. You could do this on E-trade, but the price may have moved by the time you enter in your transaction, and its pretty exhausting to sit there and calculate the multiplier constantly, and then trade based on it. So you need automated tools. There are some guys out there like Brokertech that will help you get set up for far smaller fees, but even then, to implement any strategy, I would say you want at least several hundred thousand to play with. To really do this properly though, you need access to historical data, real time market data, often level 2 market data, direct connections to exchanges, development time, etc, and all of these things are expensive. I do know some guys that have done “bedroom trading,” none have really run too far with it. Sometimes they are one-trick ponies and they find a reasonably profitable strategy that doesn’t work after time, or they just don’t have the scale (IE money) to diversify their strategies and consistently make enough money to justify the risk.

  • You say that IB has contributed to global growth. Would you say the same thing of high speed automated trading? From what I understand of it, it seems like stealing. Am I missing something?

Why does it seem like stealing ?

Let me give an example with FX. With a currency pair say EURUSD you have a spread, the difference between the buy and the sell price (a useful tip if you’re going on holiday: you can easily tell how good a price you’re getting at a currency exchange is by looking at how big the spread is). The tighter the spread, the better the prices.

Supply and demands for currency is for practical purpose changing continuously (at this very second there are thousands of people who want to buy/sell USD). But imagine currency exchanges only updated every 500ms.
Now if you’re a market maker who wants to offer a price for trading you know that supply and demand has changed since that last 500ms update, and based upon historical data you might estimate that the price is going to have moved by 10pips so you take the price you’re willing to trade at and add 10pips to the spread. Because if you don’t you might find that when the next exchange price update comes out that your price is off the market by 10pips and you’ll get slammed by people doing arbitrage trading (because your price is so off market people can buy cheaply elsewhere and sell to you at profit with no risk to themselves).

Now imagine the exchange updated every 100ms, on average the price might only move 1pip every 100ms, so rather than adding 10pips to your spread the market-maker only needs to add 1pip to their spread, so now prices for currency trading are better for everyone!

By increasing the frequency of trading you reduce the risk taken on by the market-maker and thus allow them to offer better prices because they no-longer have to account for that risk. This isn’t just theoretical, as the update frequency of FX exchanges has increased over the last decade spreads have been been dropping steadily.

IAmA Algorithmic trading developer at a large Wall St bank. AMAA

  • How do you make money and who are the losers?

The bid/ask spread. I can probably explain a bit more later, but when you hear IBM is trading at $82.50, you can neither buy nor sell it at 82.50 You can buy it for maybe 82.55 and sell it for 82.45, and a guy called the market maker keeps the spread. For this he has certain responsibilities, like making sure he will always buy your IBM shares, even when everyone is selling. Spreads used to be 10 or 20 cents wide, now they are about a penny wide. The massive volume has brought these spreads down, and out of market makers pockets. Other guys look for inefficiencies in pricing. Without getting too detailed, there are stocks out there that represent a group of 30 or 500 stocks. If you see that particular stock is not trading the price that the basket of stocks is supposed to be trading at, you buy one or sell the other, and have a theoretical profit, because they should always be the same price. Its a good and difficult question. there are so many participants in the market, who trade for very different reasons, its tough to say anyone wins or loses, but I think this is the most direct answer. For the record, I think Joe Schmoe, aka a retail trader benefits. Trading costs used to be very high.

  • What’s the salary like?

It depends. For a programmer like myself, I would say 150-500k. A lot of it is very bonus based, where base salary is around 100k. I would say 90% of these firms are based in NY and Chicago, and in NY that doesn’t make you rich.
If you do something awesome for the firm though that makes them boatloads of money, there is nothing stopping you from getting wheelbarrows full of money at year end. For a quant, there is no limit really. Most quants make in the hundreds of thousands to tens of millions.

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Related posts:

  1. Curated Interviews From Quants: Algorithmic Trading and High Frequency Trading (From Reddit’s IAmA) Part 3
  2. Curated Interviews From Quants: Algorithmic Trading and High Frequency Trading (From Reddit’s IAmA) Part 2
  3. How to Make Money in Microseconds: A Primer on High Frequency Trading
  4. 10 Curated Interviews from Investment Bankers (From Reddit’s IAmA)
  5. Curated Interviews From Traders (From Reddit’s IAmA)

2 Responses to Curated Interviews From Quants: Algorithmic Trading and High Frequency Trading (From Reddit’s IAmA) Part 1

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