Quanta: the mathematical geniuses who conquered Wall Street

In the modern stock market, the “old school” traders, like the famous Gordon Gekko, rule the ball. Now the exchanges are under the power of mathematical geniuses who use supercomputers for profit. Such people are called quanta.

The journalists of The Telegraph understood whether they were good or evil for the financial market. We present to you the main thoughts of this material.
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At seven minutes after two on the afternoon of April 23, 2013, a tweet from the Washington Associated Press appeared in the news feed. Its content: “Urgent: two explosions in the White House. Barack Obama is wounded. " The account of the agency was hacked by hackers who call themselves the “Syrian Electronic Army”. But literally in a split second, this one was noted on hundreds of computers traders on Wall Street.

All these machines have a program installed to scan any messages for keywords. For example, "explosion", "White House" and "Obama". Traders went crazy. Over the next few seconds, the Dow Jones index fell by 140 points, the capital of $ 200 billion just "leaked."

A few minutes later, the hoax was exposed, and the market returned to its previous indicators. But for many, the mere fact that a fake tweet could have such serious consequences seemed incredible. So who eventually drives Wall Street, people or cars?

If you believe that there are still people, then you are hopelessly behind the times. The last decade there has been a real technological breakthrough. The former type of trader with his hair licked back and a leather bag for $ 5 thousand has sunk into oblivion. He was replaced by powerful machines that can instantly analyze huge amounts of data and sell and buy stocks with unprecedented speed. Look at the hall where traders sit. There are no more men galloping and screaming into the phone. You will see rows of artistic appearance of citizens, quietly sitting at the screens, monitoring market performance. About 70% of transactions on Wall Street now go through a special software. Mathematical geniuses, who wrote all these programs, from now on - they are the most intelligent here.

Mathematics made their first foray into the financial world back in the late 60s. It all started with the publication in 1967 of the book “ Beat the Market ” by Edward Thorp (Edward Thorp, “ Beat the Market ”), a professor of mathematics at the University of California. In it, the author described a method that will help make money on the stock market, which he tested on playing blackjack in a casino. The system itself turned out to be so pretty that many game houses changed the rules. The method was quite simple and effective: selling securities at one price, and then buying them back at a reduced price. In 1974, Thorpe organized a hedge fund and continued to terrorize the market with his ideas.

Edward Thorpe (Time & Life Pictures / Getty Images)

At the same time, circumstances began to take shape not in favor of people engaged in pure science. After landing on the moon in 1969, the US government cut state support for science to transfer all forces to the war in Vietnam.

"A whole generation of physicists threw their universities and rushed to the stock market, which by then was in deep depression," says James Owen Weatherall, author of "Physics of Money." The guys had to live on something and many of them decided to go to the financiers. ”

A similar story occurred in Britain, when, after the collapse of the USSR, a flood of scientists from the Warsaw Pact countries rushed into the country. They brought with them new methods of analysis and a strong belief that computers can make a real revolution in predicting market behavior. Thus, a new branch of knowledge was born - quantitative analysis. It began her pedantic mathematics with strained beards and lack of taste for the accepted style in the clothes of a gentleman.

Jim Simons, a mathematician who made a significant contribution to the development of string theory, was a living legend for these guys. No one would have thought that this scientist would ever descend from his cosmic heights to the temporal problems of Wall Street. But in 1982 he founded a very successful hedge fund management company - Renaissance Technologies. One of these funds, Medallion, brought an incredible 2478.6% profit in 10 years. This is more than any other hedge fund on the planet, including the George Soros Quantum Fund.

Jim Simmons (AP)

The complex, top secret algorithm that brought success to the company continued to do its job even at zero, while the foundation existed. The profit from Medallion was about 40% per annum, which made Simons one of the richest people on the planet with a fortune of more than $ 10 billion.

Of the two hundred employees working in a building that looks like a fort on Long Island, one third have a doctorate in mathematics, physics, or statistics. Renaissance was once called the collection of the best minds in physics and mathematics in the world. They don’t hire people on Wall Street. A degree in financial sciences is also considered worthless.

Not surprisingly, the financiers of the old school eventually hated quanta. Not only because they shoved them from the top of the mountain, it’s about the difference of cultures and worldview. One of the brokers working with hedge funds, in his blog, described the experience of working with quantes as follows: “They do not have easy conversations. I learned not to even try to start an innocent conversation about the weather, while I was going with someone from them in the elevator - they do not understand that such a topic can be discussed just like that. They are sure that you are asking some serious question about weather conditions that may affect something. The same thing with jokes - the answer can only be a missing look. ”

But what are the experts in the field of quantitative analysis actually doing?

Patrick Boyle and Jesse McDougall (Patrick Boyle and Jesse McDougall) manage their hedge fund from town house on Islington. Their office is located next to an ethnic cafe whose visitors probably hate capitalism as much as they like healthy, eco-friendly food. They spend their working hours in a small room with three monitors. Their day begins at 7 and ends closer to 23.00. “We have monitors everywhere, even in the kitchen and in the living room,” says Boyle. - "We can view the figures at dinner, enter the system remotely, if in the evening we are not at home." He showed the Telegraph journalist a graph that reflects the activities of the foundation. Their curve does not descend as deeply as the overall market collapses, and grows faster than the FTSE index grows.

How do they do it?

"It's math," says Boyle. “We buy securities market data and analyze them.” It looks like a weather forecast. For example, we can with 65% confidence that the market will grow before closing. So with a probability of more than 50%, our short-term actions in the market will be successful. "

When asked who wrote the program that they use, Boyle answers "I". Next question: “How did you do it. “Gradually,” he says.

The program itself may have been written for a long time, but the speed of the transactions it provides is impressive. Many quanta use the high frequency trading approach. It involves a large number of transactions in a short period of time. “In a fraction of a second, the cost can vary by a cent. Repeat the operation a thousand times on each of the hundreds of transactions, and you get good money, ”says McDougal.

In order to dive deeper into the topic, the journalists met with Simon Jones, who until recently led the department for quantitative analysis in one large bank. In his 36 years.

“I worked with the best specialists in my business. We collected them all over the world: from China, Russia, India. We have a very competitive environment, ”he said. “Suppose I noticed that with the increase in the Dow, our British FTSE is also going up. This can make money. To do this, you need to receive information from New York and send back a decision on operations, but buy your FTSE before anyone else. ”

In this case, speed plays a pivotal role. So the providers race begins. In 2010, Spread Networks stretched a cable from New York to Chicago through the Allegheny Mountains, which won something about 1/1000 of a second of time when transferring information between stock exchanges.

In order to get such a means of communication between London and New York, the bank where Jones worked was supposed to pay out about $ 50 million. “This would give us 6/1000 of a second advantage over the rest of the players,” he says.
This game over time can be a thing not very reliable. "Warren Buffett holds, for example, Coca-Cola stocks, when they go down, he says he does not fold them, because he is confident that they will rise again," explains Jones. - “But the guys working with HFT, they are only interested in the next millisecond. But when too many people start to panic over the next millisecond, then all hopes collapse. ”

Something similar happened on May 6, 2010. On this day, there were so many deals on the New York Stock Exchange that the trading lines could not cope with the load, and the bidding decided to temporarily freeze. Between 2:30 pm and 3:00 pm, the Dow Jones Index lost and brought back about $ 1 trillion. On this day, for example, shares of the Accenture management company fell to almost zero, while Apple shares rose to $ 100,000. (We wrote about this glitch here ).

“No one knew what to expect and what to do in such a situation. And it was terrible, ”recalls the analyst who worked that day with the HFT system on the Dave Lauer exchange.

For him that day sounded the bell. “I saw how competition, who is faster, makes the state of things very fragile,” he said. In subsequent years, he had to make a difficult choice, the family expected replenishment. “I then thought, how will I explain to the child, what do I do for a living?” Dave said. He left his previous job and testified to the Senate Committee, in which he stated that the crisis was triggered by high-frequency traders.

Part of the trouble that happened on May 6th can be explained by the strategy that HFT traders follow when they make bogus offers to buy or sell in order to stimulate their competitors. On this day, it was announced deals for the sale of 19.4 billion shares, but only hundreds of millions were really sold. Most were active for a hundredth of a second. So traders checked the ground.

Is such a system reasonable, leading the market to a state of instability? Were all investments in the race for time and new technologies justified? Buffett’s business partner, Charles Manger (Charlie Munger) described HFT as “essentially a devilish invention.” “This legalizes the practice of advanced transactions,” he noted. For ordinary investors, the system does not really bring any benefits.

However, most quanta refuse to see in their work a danger to the market, although some of them express certain concerns.

“Some guys who come to trade on the market, having behind them the experience of pure science, are used to solving specific problems. Many of them believe that they are able to find a formula that perfectly describes the work of the market. This is a search for a philosopher's stone, in life it is impossible, ”explains Patrick Boyle. The problem, he said, is that behind the numbers and graphs, they no longer see people.

After 16 years in the City of London, Simon Jones plans to start traveling. “At work with a quantum one can get up quite well. But sometimes I think about the contribution that I could make to the development of society, ”he said. Johns says that together with his colleagues - the brightest minds of modern times - he worked days and nights, but only to become richer.

“As a result, it inflicts damage on those branches from which all these scientists came out - physics, chemistry, and public health. If the search for a cure for cancer were paid as much as in the City of London, this medicine would have been found long ago. ”

Quanta: the mathematical geniuses who conquered Wall Street

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