I started reading this book since it had the catchy subtitle “How to Build Your Own Algorithmic Trading Business”. I decided to see if this book could help me do exactly that, provided I put in enough effort.
I thought it was an easy read. Here are my notes on it.
Chapter 1: The Whats, Whos, and Whys of Quantitative Trading
It starts fairly slow, going over definitions, talking about success factors and demands of entering this business. It’s nothing terribly insightful, but I really enjoyed his writing style.
Chapter 2: Fishing for Ideas
Ernest starts by saying trading strategies are easy to come by, and lists a few blogs and resources. Again, nothing that a quick Google could not have produced for you. The key takeaway for me here is that sharing strategies has been a great way of quickly workshopping ideas, and is one of the reasons I started this blog! I’ll list a few of the resources he recommends:
I should probably have a closer look when I’m done with the book.
This chapter also covers some general factors affecting strategy evaluation:
- Drawdown (duration and magnitude).
- Transaction costs,
- Survivorship bias, train and test
- Momentum (does a strategy “run out of steam?”),
- Benchmarking,
- Encroachment by others.
Chapter 3: Backtesting
A lot of time is devoted to some fairly trivial programming tasks. I skipped this material as I’ve done lots of this kind of stuff before. My main takeaways here are splits and dividends. Stock returns should be adjusted based on the evolution of splits (a share could be divided into \(n\) shares, thereby lowering each of their value by \(\frac1n\)). Dividends also call for an adjustment, as the stock price drops by the amount of the dividend, \(d\), when it’s paid out to shareholders. To get an adjusted share price, \(S_a\), from the split-adjusted close price, \(S\), a little bit of maths is involved:
$$ S_a = \large(1 – \frac{d}{S}\large) \times S.$$
Chapter 4: Setting Up Your Business
In this chapter, the author goes into the nuts and bolts of retail versus propertary trading. He also spends some time on the setup needed, and recommends systems:
- Trade a good variety of financial instruments,
- Have relatively low commissions,
- have access to a deep pool of liquidity,
- and have a real-time API for data and order management.
Makes sense to me.
Chapter 5: Execution Systems
This chapter goes more into the practical details of how to set up your own system, and comments on fully vs semi-automated trading systems.
Chapter 6: Money and Risk Management
I enjoyed this chapter. There is a lovely brainteaser, which also appears on Ernest’s blog:
If the returns of a stock adhere to a geometric random walk law, and you buy this stock, are you most likely, in the long run, to make money, lose money, or be flat?
Apparently, you lose. Well, that’s not the whole story. The expected profit is zero. The most likely, the mode, is smaller than the initial investment. See the details in the blog – the commenters are great!
Ernest also touches on risk management and psychology of trading, which were great passages to read.
Chapter 7–8: Special Topics & Summary
Chapter 7 summarises mean-reverting and momentum-based strategies. I quickly skipped chapter 8…
Summary
This does not appear to be an in-depth guide to the business, but rather a very broad introduction. It was a little bit annoying that many of the links in the book are dead, even those to his own website.
I thought it was a great place to start and an easy read. This is perhaps something newbies like me need in the beginning of their journey. Great overall style, so I recommend reading it as it’s not a huge time investment.