Quantitative trading is a technical investment strategy in the financial markets that relies on mathematical formulas and computations to recognize opportunities. Employed by many advanced hedge funds and some mutual funds, quantitative trading takes much of the human element out of investment decisions. It is an alternative to qualitative trading, which is an investment technique based on financial experts' insight and analysis.
A quantitative trading strategy uses computer software programs and spreadsheets to track patterns or trends in trading behavior. Trends are uncovered based on the price of a security and the volume or frequency at which it is traded. Securities such as stocks tend to trade in upward and downward cycles. A quantitative method seeks to capitalize on those trends.
For instance, by separating trending patterns, such as when a stock is demonstrating a trend versus when it does not appear to be trading based on any trend behavior, patterns in that stock are detected. When the price begins showing signs of entering a trend period based on historical patterns, an investment opportunity might be ahead. An investment adviser might decide to enter that trading position in time to profit on that trend.
There are several distinguishing features that separate quantitative trading from a qualitative strategy. The objective behind a quantitative strategy is to uncover investment opportunities in underpriced securities, including stocks and bonds, in addition to identifying those assets that are overpriced. These factors would lead an investment adviser to make buy and sell decisions in the financial markets.
Quantitative investment techniques are also designed to evaluate and manage different risk exposures in a portfolio. Sometimes there are subtle behaviors in a financial security that can be overlooked by the human eye. By relying on mathematical formulas, an investment adviser might be better able to identify imbalances or vulnerabilities in a portfolio that could lead to potential losses if left unaddressed.
There are cost benefits tied to quantitative trading. Investment advisers often diversify across multiple securities in different regions. A quantitative trading style is designed to reduce the cost of buying and selling many securities in various transactions by streamlining those trades.
Although quantitative investing is driven largely by computer software, there is a human element required. Financial analysts still must perform scientific research on investment techniques, something on which qualitative investing is based. Nonetheless, a quantitative investment manager typically relies less heavily on a human recommendation and assessment of investment securities and more on computerized formulas.