Future perfect...

My recent adventure in NY with some of the US hedge funds brought back memories of last August where everything seemed to be going down ... A part of the meltdown as explained by every manager I met was the impact 'Quant Funds' had on the market..

Incidentally my last visit today (to end my business trip in NY) was at a hedge fund called Renaissance Technologies. This is one of those 'black box' investing idea driven fund where all of the managers managing the funds are PhD's. Most surprisingly none of these PhD's is a finance professional, they all come from Physics or Mathematical background and my first impression of these guys running a huge sum of money (USD 25 Billion) is that either these guys or I am a misnomer in the field of finance. I saw large boxes of computer doing all the trading and immediately thought - is this the way future is going to be!? As I sat across the table with these PhD's I tried to figure out what they do which makes the operation so special - what algorithms go into making these systems work; and again amazingly the answer was 'Price' and 'Volume'. Two variables determining what happens next to the price. It was really amazing how each of those algorithm would generate a trading signal and let us know what the best trading idea is for the next 2-3 days.

It became more and more convincing that what I saw was the future of all trading to happen in probably 10 years time. However, I had my own set of apprehensions. To my surprise, when I asked one of the PhD's that met me about how an algorithm can capture human behaviour, he told me it couldnt and then I wondered as to how one could trade without knowing the market instinct. And at that moment all my conviction in quant systems was gone...

what I took away from this meeting was systems help you decide a lot of things, however, can't be decision makers themselves. Firstly, because (however ironic it may be) systems dont understand emotions, they dont understand that fact that humans behaviour is as random as randomness can get..Secondly, no system in the world can tell you what the corporate earnings are going to be 2 years down the line ... Principally how do u adjust for irrational behaviour? I understood that price captures present human behaviour, however, no one knows what happen's tomorrow...

This is what exactly happened to these quant funds in August, systems failed to take into account the irrationalism in the market. They failed to understand that there is more to markets than price and volume; something we know as fear and greed ... and no matter how good the present is ..future cant be perfect !b