Quant Trading and Dark Pools

BarroMetrics Views: Quant Trading and Dark Pools

In his current book, The Master Swing Trader Toolkit, Alan Farley argues that quant trading has forever changed the pattern of trading, at least for Stock Index futures and equities. I am not sure how much I agree with him about that.

Certainly quant trading and dark pools appear to have increased volatility.  The S&P had been grinding up since February 2010 on reduced volume and range. On Farley’s argument, this was because public participation was missing and the quants were for the most part trading among themselves.

I do agree that the death of the market makers was brought about by the ECN’s.  Market makers and specialists provided liquidity because they had to take positions against the general flow. There is no such obligation on the quants. As a result, either because they are all exiting at the same time or because they are keen to be short (or long at the same time), we see a rush of orders in the same direction.

Add to that public demand also hitting the bid (or the offer) and you will have the sort of volatility that we saw the other day.

If the SEC is serious about ‘curbing’ increasing volatility it will:

  • Provide rules that will in effect bring back the specialists & market makers – perhaps the quants can take their place and
  • Amend or abolish the ‘trade-through’ rule so that abuses (e.g. placing illusory orders at the top of bid-ask; you know the bids that melt away instantly in down moves[and offers that disappear in up moves])

The world of the quants is the nano-second world. At the moment we can still compete but our edge is in the higher timeframes. Seeking to trade in their world and expecting to retain an edge seems to me to be an impossible task.

7 thoughts on “Quant Trading and Dark Pools”

  1. Hi Ray, Wasnt there some hedge funds with Nobel prize winners,using quant analysis to trade, that went belly up? cheers baz

  2. Hi Baz

    LTCM – but the modern quants like the Medallion Fund are a different breed.

    LTCM used a arbitrage method that sold and kept on selling when the spreads widened beyond the norm. Spreads eventually did return to normal but it was too late for LTCM.

    Medallion is reputed (no one knows for sure) to comb through data looking for short term patterns in ultra short timeframes.

  3. Ray;

    Please continue to push this dialogue. I’ve been on the street for 40+ years, just show us the trades.

  4. yes yes, longer time frame is the way to go, reduce the leverage is the key to survival.

    they don’t seems to be active in our local market (yet).


  5. “Certainly quant trading and dark pools appear to have increased volatility. The S&P had been grinding up since February 2010 on reduced volume and range.”

    increased volatility and reduced range? – you don’t need to be a ‘quant’ to know that statement is incompatible.

  6. Hi Bootstrap

    Thanks for picking that up. Poorly articulated on my part.

    What I meant was when the quants are predominantly alone in the game, you see the grinding type activity we saw in Feb.

    Once the public gets involved and moves the market in a direction opposite to the quant’s previous direction (and/or some stimulus hits the markets so the majority of the quants hit the exit door at the same time), you get the volatility you saw on last Thursday.

    The key here is the market maker is no longer present to be a stabilising force.

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