The capitalist economy is one of humanity’s greatest accomplishments: although it has undoubtedly had many adverse effects on society in recent times, its benefits towards advancing the human condition and creating a society with vastly higher quality-of-life far surpass any of its detriments. The stock market is the crown jewel in the capitalist crown—being able to trade pieces of ownership in companies, also known as stocks, in order to fund further growth has increased competition, advanced technology, and has increased the overall wealth in our society today. But how does the stock market really work? And who really controls all of it? Quantitative analysis is a powerful yet unsung tool that buttresses the stock market and has done so for decades. The efforts of the researchers who use it to improve the stock market cannot go understated, yet their real work remains shrouded in obscurity.
In short, the stock market is a physical or virtual marketplace in which shares of a company are traded between individuals or companies for monetary value. These shares are given out in order to fund development of new products and technology for the company in question. The idea of the stock market originated in Amsterdam, but the stock market as we know it today started in the late 1700s. A group of traders and merchants in New York City wrote and signed the Buttonwood Tree Agreement, which stated that these traders could come to that tree and trade stocks and bonds in their company. This informal agreement soon transformed into a formal marketplace known as the New York Stock Exchange (NYSE), still currently the premier stock exchange in the world. After the Great Depression, other stock exchanges were formed all around the world and new tracking metrics, such as the Dow Jones Industrial Average and the S&P 500 were also formed. More importantly, however, the advent of computers in the mid-1900s paved the way for a new, more advanced form of stock trading known as quantitative analysis, forever changing the state of the stock market.
The idea of quantitative analysis, and its parent concept fundamental analysis, can both trace their roots to Security Analysis, a book written by professors Benjamin Graham and David Dodd from Columbia Business School. Fundamental analysis states that a stock’s intrinsic value stems from both its quantitative features, such as cash flow, debt-to-equity ratio, and P/E ratio, as well as qualitative features, such as its business model and its competitive advantage. When a keen investor analyzes these factors, they can determine whether a stock is undervalued and should thus be bought or if it is overvalued and should thus be sold. Warren Buffett, the famed investor and founder of Berkshire Hathaway, popularized fundamental analysis as a trading metric and currently uses both quantitative and qualitative analyses when trading stock. Many other traditional investors still use fundamental analysis when managing portfolios. However, with the development of computers, quantitative analysis became particularly striking as computers could perform calculations millions of times faster than any human. Some of the pioneers in the field include James Simons, who founded Renaissance Technologies, and David E. Shaw, who founded D.E. Shaw and Company, now two of the most powerful quantitative trading firms in the world.
Quantitative analysis involves the usage of mathematical models and algorithms to predict the stock price of a company based on its quantitative features. Quantitative traders routinely use highly complex mathematics, such as stochastic calculus, linear algebra, differential equations, and discrete mathematics to create these models. Thus, most, if not all, quantitative researchers and traders have some sort of background in a math-heavy field, such as computer science, statistics, physics, mathematics itself, or some combination of the above. Quantitative strategies make use of publicly available data to find patterns and correlations between stock price and one or many factors used in quantitative analysis. For example, a quantitative strategy that correlates stock price with trading volume may notice that trading volume increases when a particular stock’s price hits $25 and decreases when it hits $30. The trader will then instruct the computer to automatically buy the stock when it hits $25 and sell when it hits $30. The advantage in quantitative trading at large companies is that traders have access to a near-unlimited pool of capital to buy stock. Thus, the seemingly measly $5 gain could be a matter of $5 million if the company is trading a million shares. This is why using computers is so important: making trades millionths or even billionths of a second faster than a different company can be the difference between making or losing millions of dollars.
Quantitative trading is one of the most lucrative careers on the market: new graduates with even just a bachelor’s degree receive offers of up to $300,000 per year—a salary that most people don’t even see within their lifetime. Of course, these offers only accumulate if you are the best of the best with innate mathematical and trading sense. This is why many prestigious quantitative trading firms, such as Citadel, Jane Street, D.E. Shaw, and TwoSigma, almost exclusively hire from similarly prestigious colleges such as Harvard, MIT, Princeton, and Cornell. Despite the extremely high pay and prestige associated with a quantitative trading career, it’s quite possible that the job is somewhat underrated in society because of the extremely high requirements and competition in the applicant pool. These prestigious firms are rather small in size, as they only need a small number of developers to carry out their trades. Thus, many of these companies are more competitive to get accepted into than many top tech companies such as Amazon, Apple, and Microsoft. Additionally, it’s not all sunshine and rainbows at quantitative trading firms: many of these firms work their employees to the bone, ordering 70- and even 80-hour workweeks. For some, however, these unfortunate working conditions are justified for the high pay that the employees receive. Nevertheless, the career is a highly interesting and lucrative one for those fascinated by mathematics and its applications in the finance world.
Make sure to check out our other articles below regarding the most interesting and underrated careers in STEM!