Thursday, August 9, 2007

Fun With Stock Markets (and Soon, Commodities Too!)

David Gaffen posts at the WSJ's MarketBeat blog:

In today’s Wall Street Journal, Henny Sender and Kate Kelly note the troubles among so-called “quant” funds, which rely on models that haven’t been working so well lately. “Quant funds — “quant” stands for quantitative — generally operate by building computer models of market behavior and then allowing the computer programs to dictate trading,” they write. “A recurring characteristic of the recent trouble in financial markets is that many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the market environment had become.”

That was exactly the point of this line:

"-they may have some nifty swaps and other derivatives to hedge against the one and two standard deviation event risk, but what about the 3, 4 and 5 SD risks?"

in the post "Magical Markets, Enron and GE and a New Word"

If you can't get enough of quant trading, we had this news a couple weeks ago (this version is from Structured Products, Aug. 3):

UBS Launches Algorithmic Strategy System for Commodities

Which should not be confused with Al Gore rhythmic,
here's a couple versions of Al doing the Macarena.

Back to UBS:

UBS has launched an algorithmic strategy system dubbed UBS Commodities Portfolio Algorithmic Strategy System (Comm-PASS), an index which exploits momentum in the commodity markets to generate returns through automated long and short strategies.

The portfolio comprises a basket of strategies on 19 commodity futures markets from the five different commodity sectors: energy, precious metals, base metals, agriculture, and livestock.

“The strategy, which will be used by upcoming structured products, is published as an index which allows easy referencing when tracking the performance of the algorithm,” says James Paget, co-head of EMEA structured commodity sales. “The strategy comprises the most liquid commodities, with individually tailored algorithmic parameters, resulting in a robust portfolio.”

Structured Products
"Structured Products is the only magazine dedicated to the wholesale market for derivatives-based investment products."

Update: I was informed that we had also addressed algorithmic trading in the post "Alternative Energy Stocks"( I just babble, I need folks to tell me when we've plowed the ground in earlier posts):

One reason the big nodes (London, New York City, Hong Kong) are still the big nodes is that the speed of light is 11.8 inches per nanosecond. The greater the distance between nodes the slower your execution. Time is indeed money and it can be measured by the cesium-133 standard: 9,192,631,770 cycles (Hz), or turned around, every foot away from the node costs you 9.192 ticks on the atomic clock (and that's photons in a vacuum, in real life you're using fiber-optics or, worse, electrons in copper).

Personally, I think that basing your competitive advantage on execution speed is a mug's game. As IBM said in their Feb. 27 Financial Services newsletter:

"But what happens when every competing firm plugs into algorithmic trading and speed and execution become commodities? Are there other advantages algorithmic transactions can offer?"

Going forward, ideas matter more than money. The kind of intelligence that will be the in highest demand will be the ability to make, as James Burke put it, "Connections".
And that's where AltEnergyStocks nailed it.