Quantitative trading tends to be mired in speculation and myth, simply because it involves complex algorithms and a specialized trading structure that would seem foreign to anyone outside the industry. However, a quantitative trading firm is a business just like any other and should be thought of as such. Every business follows its own model, usually shaped by the industry or market it operates within.
While I have invested a lot of time delving into the technology of quantitative trading in order to provide a basic understanding to anyone who’s unfamiliar with it, it can be just as important to study its business structure through the lens of a startup oriented toward long term growth. At the end of the day, algo trading firms must have smart, sophisticated and effective algorithms to take full advantage of the electronic infrastructure at work. A major step in developing such algorithms is hiring the right people to do the job, which is at the heart of any sustainable business model.
The way I see it, there are two primary means through which algo trading firms do business in order to expand and remain competitive in the market. They are:
1. Bringing in accomplished traders with proven track records
Only about 10% of new startups succeed, and while venture capitalist support can often be viewed as an indicator of a startup’s potential, as many as three-quarters of venture-backed startups fail right away. With such a high margin of error, any entrepreneur looking to start their own business should know what differentiates those that succeed from those that fail. To stay afloat and expand, it really comes down to hiring the right people.
Investing in new traders is similar to venture capitalists investing in a new startup; the idea may seem great on paper, but only a select few will ultimately be very successful. Furthermore, investing at a later stage significantly increases the likelihood of a startup’s success. Second and third round financing is more likely to have positive returns than first round.
Becoming established begins with seeing opportunity in intelligent people and ideas. Seek out the candidates with proven track records. The tradeoff is that the more experienced the people you hire are, the more you will have to pay them to retain their services so the returns may be smaller; however, it is almost always worth the investment in top talent for perpetual growth.
2. Bringing in traders from different backgrounds
The next major consideration for algo trading firms in the development phase is bringing in not just the best talent, but a diversity of talent as well. It is important to add traders from many different backgrounds, assets classes, geographical markets, and domains (trading methodologies and strategies). Traders should represent a range of ideas and especially domains. For example, one trader can focus on ETF arbitrage and the other on statistical arbitrage, for the most part, mutually exclusive domains. Diversification is crucial in order to make the expatiation of new traders successful.
Ultimately, algo trading companies are businesses just like any other. Only the sharpest, most motivated, and most creative minds will succeed in this field, so it is up to the founders to identify and bring in the best talent for the highest return on investment.