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"don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting

"don't forget that even the non professionals making mistakes will get less losses and a return closer to a long term index when better quant system are betting agains each other and keeping prices close to their optimum levels." Do you have an argument/explanation for this? Also, why are the quant systems necessarily betting against each other? "It is not certain at all that the worst professional models will make money just because there are non professionals that are even worst." I didn't mean to imply that its a certainty, only that its a possibility. I mean our whole argument is about some possible utopian future, right? "I still maintain that as the models get better and better while they bet against each other, the margin for profit is reduced and the sector as a whole should shrink and that's a victory for capitalism." Aren't you just saying capitalism works? Can't I say the same thing about all those darn internet startups extracting value from me because they're providing me information? Would you use the same argument to conclude that the space of internet startups will shrink?

yummyfajitas 16y ago
In a completely efficient market, any stock is just as good as any other - you make or lose money solely due to chance. Nonprofessionals will only take trading losses if they are unlucky . (Of course, a non-professional who wishes to treat eTrade as a casino may lose money on transaction costs.) You absolutely can say the same thing about internet startups extracting value by providing you information - but you are incorrect to conclude that the space of internet startups will shrink. In fact, what will shrink is profit margins - as more startups are created, all the easy alpha is off the table. Witness what is happening to newspapers right now.
- secretasiandan 16y ago
  re completely efficient markets, you're right. My eyes focused on the "making mistakes" part and missed the "closer to" part. I guess I could throw something in there about gambler's ruin, but that would be a little pedantic. re the space of internet startups : To be clear, I wasn't concluding one way or the other, just asking him to apply the same logic to something he might have positive bias towards and see if he comes to the same conclusions. Also, rather than number of companies, I think the market cap/total profit of the companies is a better metric. I'm not sure that company margins in internet startups or quant finance will shrink. I haven't thought too much about it but I think they might even grow as information/efficiency attains greater value. Margins per action done might shrink but number of actions will grow. Isn't this the whole story of HFT? Further, old lines of business will have their margins shrink as the service becomes commoditized. But new high(er) margin lines of business will spring up in their place.
  - yummyfajitas 16y ago
    In the case of HFT the number of actions has grown only because there was alpha sitting on the table, but it wasn't worthwhile for human market makers to chase it. Think about a strategy which generates $100/day trading OTSS (Obscure Thinly Traded Symbol), a security with a $0.25 bid/ask spread. No human will waste their time on this strategy, so $100/day of alpha is left sitting on the table. HFT allows a computer to chase after this $100, $50 on some other stock, etc. This is simply a case of 3 programmers + computers doing work which was unprofitable for humans to do. Similarly, twitter didn't exist before the internet because no human would be willing to earn $0.0003/day hand-delivering short messages to anyone who cared to listen, being paid to verify that "yes, this message really came from Mallika Sherawat". Once the market becomes saturated, the bid/ask on OTSS will shrink to $0.10 and the algorithm will only generate $40/day. We are already approaching that point in HFT. As for margins, they may grow if demand increases. I was really speaking about a situation of increased competition with all else held equal.
BenoitEssiambre 16y ago
"Do you have an argument/explanation for this? Also, why are the quant systems necessarily betting against each other?" The firms with the good models in the system will tend to keep prices near their optimal values by trading amongst each other so when the dumber investor makes his trades he will get near these prices. It's like in the allegory when the lines are at their optimal because there are enough individuals with knowledge of the fast line, a person that doesn't know about the fast line picking at random will get some benefits because the line lengths are already optimized. "Would you use the same argument to conclude that the space of internet startups will shrink?" As an example, consider the bigger gaming firms which now have difficulty competing in the mobile gaming market because the whole process has become too efficient for firms that are capital intensive. On the customer's side of things, they get to chose from a huge library of games most costing less than the price of a cappuccino. More games for less money, that's market efficiency. I guess you could say that if the investment opportunities grow as a whole, the quant market could grow with it but it should shrink relative to it as it gets more competitive. Also, what yummyfajitas said.

yummyfajitas 16y ago

In a completely efficient market, any stock is just as good as any other - you make or lose money solely due to chance. Nonprofessionals will only take trading losses if they are unlucky . (Of course, a non-professional who wishes to treat eTrade as a casino may lose money on transaction costs.) You absolutely can say the same thing about internet startups extracting value by providing you information - but you are incorrect to conclude that the space of internet startups will shrink. In fact, what will shrink is profit margins - as more startups are created, all the easy alpha is off the table. Witness what is happening to newspapers right now.

secretasiandan 16y ago
re completely efficient markets, you're right. My eyes focused on the "making mistakes" part and missed the "closer to" part. I guess I could throw something in there about gambler's ruin, but that would be a little pedantic. re the space of internet startups : To be clear, I wasn't concluding one way or the other, just asking him to apply the same logic to something he might have positive bias towards and see if he comes to the same conclusions. Also, rather than number of companies, I think the market cap/total profit of the companies is a better metric. I'm not sure that company margins in internet startups or quant finance will shrink. I haven't thought too much about it but I think they might even grow as information/efficiency attains greater value. Margins per action done might shrink but number of actions will grow. Isn't this the whole story of HFT? Further, old lines of business will have their margins shrink as the service becomes commoditized. But new high(er) margin lines of business will spring up in their place.
- yummyfajitas 16y ago
  In the case of HFT the number of actions has grown only because there was alpha sitting on the table, but it wasn't worthwhile for human market makers to chase it. Think about a strategy which generates $100/day trading OTSS (Obscure Thinly Traded Symbol), a security with a $0.25 bid/ask spread. No human will waste their time on this strategy, so $100/day of alpha is left sitting on the table. HFT allows a computer to chase after this $100, $50 on some other stock, etc. This is simply a case of 3 programmers + computers doing work which was unprofitable for humans to do. Similarly, twitter didn't exist before the internet because no human would be willing to earn $0.0003/day hand-delivering short messages to anyone who cared to listen, being paid to verify that "yes, this message really came from Mallika Sherawat". Once the market becomes saturated, the bid/ask on OTSS will shrink to $0.10 and the algorithm will only generate $40/day. We are already approaching that point in HFT. As for margins, they may grow if demand increases. I was really speaking about a situation of increased competition with all else held equal.

BenoitEssiambre 16y ago

"Do you have an argument/explanation for this? Also, why are the quant systems necessarily betting against each other?" The firms with the good models in the system will tend to keep prices near their optimal values by trading amongst each other so when the dumber investor makes his trades he will get near these prices. It's like in the allegory when the lines are at their optimal because there are enough individuals with knowledge of the fast line, a person that doesn't know about the fast line picking at random will get some benefits because the line lengths are already optimized. "Would you use the same argument to conclude that the space of internet startups will shrink?" As an example, consider the bigger gaming firms which now have difficulty competing in the mobile gaming market because the whole process has become too efficient for firms that are capital intensive. On the customer's side of things, they get to chose from a huge library of games most costing less than the price of a cappuccino. More games for less money, that's market efficiency. I guess you could say that if the investment opportunities grow as a whole, the quant market could grow with it but it should shrink relative to it as it gets more competitive. Also, what yummyfajitas said.