A quantitative trading system consists of four major components:
- Strategy Identification - Finding a strategy, exploiting an edge and deciding on trading frequency
- Strategy Backtesting - Obtaining data, analyzing strategy performance and removing biases
- Execution System - Linking to a brokerage, automating the trading and minimizing transaction costs
- Risk Management - capital allocation per trade
Strategy Identification - Finding a strategy, exploiting an edge and deciding on trading frequency
Many of the strategies you will look at will fall into the categories of mean-reversion and trend-following/momentum. A mean-reverting strategy is the theory suggesting that prices and returns eventually move back toward the mean or average. A momentum strategy is an investment strategy that aims to capitalize on the continuance of existing trends in the market. In stock trading, it is jumping on board with the crowd hoping to ride a stock up or down.
Another hugely important aspect of quantitative trading is the frequency of the trading strategy. Low frequency trading (LFT) generally refers to any strategy which holds assets longer than a trading day. Key2Options was designed with this type of trading. It is an end of day program and therefore does not participate in high frequency trading (HFT) where trades are bought and sold continually throughout the day.
The goal of backtesting is to provide evidence that the strategy identified via the above process is profitable when applied to historical data. This sets the expectation of how the strategy will perform in live trading. However, backtesting is NOT a Holy Grail. There is no Holy Grail in trading. Backtesting can help eliminate strategies you thought were valid or validate them. With Key2Options you have 9 years’ worth of historical stock and Options data to validate your trading model.
In order to carry out a backtest procedure it is necessary to use a software platform. We eliminate the need to be an expert in C++, Python or MATLAB computer programming. For traders looking to take emotion out of their trading, look no further. Key2options has brought algorithmic trading to the retail trader. Create a trading plan, then trade your plan knowing you have back tested your strategy with your buy and sell signals as well as your set of risk management rules.
One of the benefits of Key2Options is that the execution of a trade can be done directly from our platform through Tradier Brokerage Inc.
An execution system is the means by which the list of trades generated by the strategy are sent and executed by the broker. Key2Options has a fully-automated high-performance Application Programming Interface (API) with Tradier Brokerage. This means you can create and trade your model directly from the Key2Options platform. Transaction costs can make the difference between an extremely profitable strategy and an extremely unprofitable strategy. As a member of Key2Options, you get unlimited trades commission free.
"Risk" is all encompassing in trading. It can include technology risk, such as your computer crashing to events like the Flash Crash. Risk management also encompasses capital allocation. In Key2Options, when we discuss risk, it includes risk per trade as well as trade management.
Personality Traits and Trading
Are you a risk taker or risk adverse? Will you be willing to stay the course of the program in both good times and bad? Strategies will have vastly different performance characteristics. There are certain personality types that can handle more significant periods of drawdown, or are willing to accept greater risk for larger return.
Trading is a big boy/girl game and it requires a significant degree of discipline, patience and emotional detachment. Once you can eliminate the fear and greed and what the money can buy, it becomes about the process.
You have to be willing to use the signals you created and not impose your feelings when trading. This can be difficult if you have a drawdown. Remember that risk is generally commensurate with return. If you want a homerun, then build your model with far out of the money trades but realize you will only win maybe 2 out of 10 times. Many clients don’t mind smaller profits with a better win frequency. It’s up the individual to find their own style.
Key2Options is designed for low frequency trading, usually trades lasting from 1-10 days. Although we all love instant gratification, sometimes trades take time to play out in your favor. Key2Options is not a holy grail, but it will help you make rational trades not emotional ones.
Key2Options has several different indicators that can be used in building your quantitative model. From indicators like RSI or Bollinger bands to using the calendar for systematic buys and sells. If you have a strategy not in our program, we can also custom build your model. Furthermore, for new traders, we have our proprietary State Modeling which classifies each stock or index as bullish or bearish.
From here, you can create and backtest your trading model using historical stock or options pricing data going back to 2007. Once you have vetted your model, trade it directly from the platform.