DIY Quant strategies:

Is it possible to roll your own?

Jess Stauth, PhD

VP Quant Strategy
Bay Area Algorithmic Trading Meetup
Hacker Dojo * February 6, 2014
What makes a good equity quant strategy?

 Intuition. If you can’t explain why it works, it doesn’t

work.

 Reproducibility. If you can’t backtest it, it doesn’t work

(note the inverse does not necessarily hold).

 Access to data. If you can’t get the signal (or get it in

time) you can’t trade it. ($$$)

 Capacity/Execution You can’t push a camel through the

eye of a needle. (1/$$$)
 5 Basic Quant Strategies

1. Mean Reversion – What goes up… (special case: Pairs Trade)

2. Momentum – The trend is your friend.

3. Valuation – Buy low, sell high.

4. Sentiment – Buy the rumor, sell the news.

5. Seasonality – Sell in May and go away.

Out of scope for today’s talk:

 Acronym soup (e.g. ML, OLMAR, PCA, ICA, OLS, etc.)
 Portfolio construction, risk optimization, etc.
 Asset clases
 Pairs Trading

 Intuition: Find two assets linked to a single underlying ‘value’

and exploit transient mispricing between them.

 Reproducibility: The phenomenon is well documented1,2.

 Data: For basic strategies all you need is pricing.

 Capacity: Can be quite small depending on the instruments.

Common pitfalls:

 Ignore the intuition requirement at your own peril! Cointegration works great, until it doesn’t.

 Market neutral or ‘hedged’ strategy, so you are forgoing any upward drift in the longer term.

1. Pairs Trading, Vidyamurthy 2004

2. Quantitative Trading, Chan 2009
 Pairs Trading

Simplistic Intuition (cont’d): If you assume the spread between stock 1 and stock 2 is
‘stationary’ and ‘normally distributed’, then statistically you should be able to make money
by ‘buying’ or ‘selling’ the spread when it takes on extreme tail values.

Zx = (Price Stock1 – Price Stock2)/ Price Stock1

 Pairs Trading: EWA/EWC Pair

6/06 – 6/12
Huapu Pan (NYC Algo Trading meetup member) Posted 12/19/13
“Ernie Chan’s EWA/EWC Pair Trading”
https://www.quantopian.com/posts/ernie-chans-ewa-slash-ewc-pair-trading
 Momentum Trading

 Intuition: Comes in many flavors (stock level, sector level, asset

class level) but comes back to the behavioral bias of ‘herding’.

 Reproducibility: The phenomenon is well documented1.

 Data: For basic strategies all you need is pricing.

 Capacity: Can be quite small depending on the instruments.

Common pitfalls:
 The trend is your friend, until it isn’t. Reversals can be devastating, especially when using
leverage.
1. Jegadeesh and Titman, Returns to Buying Winners and Selling Losers: Implications for Stock
Market Efficiency. Journal of Finance March 1993
2. Faber, A Quantitative Approach to Tactical Asset Allocation. Journal of Wealth Management 2013
 Momentum Trading

Simple rules based approach

 Rank 1 > N stocks (sectors) by : [r20 – r200]
 Buy top K stocks (sectors) where absolute
momentum (20 vs. 200 day MA) > some
threshold.
 Else, hold cash.
Momentum Trading – Meb Faber RS Strategy

Backtest range: 11/04 – 2/13

John Chia Posted Feb 2013
“Mebane Faber Relative Strength Strategy with MA Rule”
https://www.quantopian.com/posts/mebane-faber-relative-strength-strategy-with-ma-rule
 Valuation

 Intuition: In a nutshell, bargain shopping. Use fundamental ratio

analysis to identify stocks trading at a discount (or premium) and
buy (or sell) them accordingly.

 Reproducibility: The phenomenon is well documented.

 Data: Requires good coverage (breadth and depth) of

normalized corporate fundamental data.

 Capacity: Small cap stocks can be riskier, and higher friction to

trade.
Common pitfalls:

 Some cheap stocks are cheap for a reason. “Catch a falling knife” adage.
 Valuation

Simple example: use price to earnings ratio as a proxy for ‘value’

where low P/E looks ‘cheap’ and high P/E looks ‘expensive’.

 Rank universe 1-100 (or sector universe) on P/E

 Long only: buy the bottom (lowest P/E) decile
 Market neutral: buy the bottom decile, sell the top decile

In practice, a quant model would typically blend a number of

backward looking ratios an forward looking estimates along with
making sector specific adjustments and other bells, whistles.
 Valuation: Screen on corporate fundamentals

Backtest range 11/25/2009 – 10/10/2013

Sam Lunt (11/4/2013) “Using Fetcher with Quandl”
https://www.quantopian.com/posts/using-the-fetcher-with-quandl
Sentiment: Short sellers
 Intuition: Follow the (short) money. Short sellers are the ‘smart
money’, their trades are $ for $ higher conviction (to balance
risk).

 Reproducibility: The phenomenon is well documented.

 Data: Bi-monthly (delayed) short interest can be scraped from

NASDAQ. Borrow rates, real-time daily short interest data
aggregated from brokers is available for $$$.

 Capacity: Can be quite small depending on the instruments.

Common pitfalls:

 Beware the Short Squeeze! Crowded short trades can lead to a squeeze as short sellers rush to close
positions.
Sentiment: Short sellers

 Rank stocks 1 > N on Days To Cover ratio*

 Buy top 10%, short bottom 10%
 Rebalance periodically

*Days to cover = Shares Held Short

Avg Daily Trade Share volume

The number of days of ‘average’ trading it would take to

unwind the existing short positions.
Sentiment: Short sellers – Rank on Days to Cover

Backtest range: 3/15/12 – 3/15/13

Fawce (April 2013)
“Ranking and Trading on Days to Cover”
https://www.quantopian.com/posts/ranking-and-trading-on-days-to-cover
 Seasonality

 Intuition: Sometimes (calendar driven fund flows

e.g. month end).

 Reproducibility: There’s healthy debate on this

one.

 Data: end of day pricing and a calendar.

 Capacity: Depends on the instruments.

Common pitfalls:
 Overfitting / data mining is rampant in this type of analysis.
 Seasonality

Simplest example is a simple 100% stock/bond annual

rotation model.

 Buy and hold equities (SPY) October thru April

 Buy and hold bonds (BSV) May thru Sept.
 Seasonality: Sell in May

Backtest range: 10/1/09 – 12/31/12

Jess(May 2013)
“Sell in May and go away”
https://www.quantopian.com/posts/time-to-sell-in-may-and-go-away
Which of these strategies are most popular among
the ‘retail’ or individual quants using Quantopian?

 Mean Reversion
 Momentum
 Valuation
 Sentiment
 Seasonality
 Other
 25 Top Shared Algorithms of All Time
Combo Rank Post Title Replies Views Clones
1 Google Search Terms predict market movements 64 31913 809
2 OLMAR implementation 64 26039 697
3 Easy Volatility Investing by Tony Cooper @ Double-Digit Numerics 57 15117 839
4 Global Minimum Variance Portfolio 28 10222 700
5 discuss the sample algorithm 12 18348 2882
6 ML - Stochastic Gradient Descent Using Hinge Loss Function 10 20400 972
7 Mebane Faber Relative Strength Strategy with MA Rule 22 11104 617
8 OLMAR w/ NASDAQ 100 & dollar-volume 31 7760 697
9 Bollinger Bands With Trading 18 8363 560
10 Brent/WTI Spread Fetcher Example 17 10821 327
11 Ernie Chan's Pairs Trade 15 10387 328
12 Ranking and Trading on Days to Cover 4 24906 379
13 Using the CNN Fear & Greed Index as a trading signal 18 9212 318
14 Determining price direction using exponential and log-normal distributions 9 9539 606
15 Time to sell in may and go away? 27 8192 261
16 Simple Mean Reversion Strategy 6 11794 270
17 Neural Network that tests for mean-reversion or momentum trending 4 10062 402
18 Using weather as a trading signal 6 11940 199
19 Momentum Trade 5 8800 455
20 Trading Strategy: Mean-reversion 13 8228 213
21 Global market rotation strategy 53 7621 94
22 trading earnings surprises with Estimize data 34 7496 129
23 Turtle Trading Strategy 11 7815 299
24 SPY & SH algorithm - please review 21 7443 194
25 New Feature: Fetcher! 27 7507 108
TOTALS: 576 311,029 13,355
 25 Top Shared Algorithms of All Time
Combo Rank Post Title Replies Views Clones
1 Google Search Terms predict market movements 64 31913 809
2 OLMAR implementation 64 26039 697
3 Easy Volatility Investing by Tony Cooper @ Double-Digit Numerics 57 15117 839
4 Global Minimum Variance Portfolio 28 10222 700
5 discuss the sample algorithm 12 18348 2882
6 ML - Stochastic Gradient Descent Using Hinge Loss Function 10 20400 972
7 Mebane Faber Relative Strength Strategy with MA Rule 22 11104 617
8 OLMAR w/ NASDAQ 100 & dollar-volume 31 7760 697
9 Bollinger Bands With Trading 18 8363 560
10 Brent/WTI Spread Fetcher Example 17 10821 327
11 Ernie Chan's Pairs Trade 15 10387 328
12 Ranking and Trading on Days to Cover 4 24906 379
13 Using the CNN Fear & Greed Index as a trading signal 18 9212 318
14 Determining price direction using exponential and log-normal distributions 9 9539 606
15 Time to sell in may and go away? 27 8192 261
16 Simple Mean Reversion Strategy 6 11794 270
17 Neural Network that tests for mean-reversion or momentum trending 4 10062 402
18 Using weather as a trading signal 6 11940 199
19 Momentum Trade 5 8800 455
20 Trading Strategy: Mean-reversion 13 8228 213
21 Global market rotation strategy 53 7621 94
22 trading earnings surprises with Estimize data 34 7496 129
23 Turtle Trading Strategy 11 7815 299
24 SPY & SH algorithm - please review 21 7443 194
25 New Feature: Fetcher! 27 7507 108
25 Top Shared Algorithms of All Time
Categorized
Volatility Technical Seasonality
5% 3% 3%
Portfolio Risk
6%

Mean
Reversion
Momentum 37%
18%
Area ~ page views
Sentiment
28%

What’s missing from this picture??

Thank You.

Questions?