Systematic trading (also known as mechanical trading) is a way of defining trade goals, risk controls and rules that can make investment and trading decisions in a methodical way. Systematic trading includes both manual trading of systems, and full or partial automation using computers. Although

technical Technical may refer to: * Technical (vehicle), an improvised fighting vehicle * Technical analysis, a discipline for forecasting the future direction of prices through the study of past market data * Technical drawing, showing how something is co ...

systematic systems are more common, there are also systems using fundamental data such as those in equity long:short hedge funds and GTAA funds. Systematic trading includes both high frequency trading ( HFT, sometimes called

algorithmic trading Algorithmic trading is a method of executing orders using automated pre-programmed trading instructions accounting for variables such as time, price, and volume. This type of trading attempts to leverage the speed and computational resources of ...

) and slower types of investment such as systematic trend following. It also includes passive index tracking. The opposite of systematic trading is discretionary trading. The disadvantage of discretionary trading is that it may be influenced by emotions, isn't easily back tested, and has less rigorous risk control. Systematic trading is related to quantitative trading.

Quantitative trading Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. In general, there exist two separate branches of finance that require ...

includes all trading that use quantitative techniques; most quantitative trading involves using techniques to value market assets like

derivative In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. F ...

s but the trading decision may be systematic or discretionary.

History

Systematic trading began with the growth of computers in the 1970s. The

Designated Order Turnaround SuperDot was the electronic system used by the New York Stock Exchange to route market orders and limit orders from investors or their agents to a specialist located on the floor of the exchange. SuperDot was the upgraded form of the previous ele ...

(DOT) system used by the

New York Stock Exchange The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District of Lower Manhattan in New York City. It is by far the world's largest stock exchange by market capitalization of its listed c ...

to electronically route orders. In the 1990s, various trading strategies were developed by major banks, including statistical arbitrage, trend following and mean reversion. High-frequency trading strategies that combined computing power, speed, and large databases were gaining more popularity due to their success rates. After 2000, millions of trades were executed by the largest hedge funds in mere seconds with their

black box In science, computing, and engineering, a black box is a system which can be viewed in terms of its inputs and outputs (or transfer characteristics), without any knowledge of its internal workings. Its implementation is "opaque" (black). The te ...

systems.

Approach

Suppose we need to replicate an index with futures and stocks from other markets with higher liquidity levels. An example of a systematic approach would be: # Identify, using

fundamental analysis Fundamental analysis, in accounting and finance, is the analysis of a business's financial statements (usually to analyze the business's assets, liabilities, and earnings); health; and competitors and markets. It also considers the overall state ...

, which stocks and futures should be used for replication. # Analyze correlations between the targeted index and selected stocks and futures, looking for the strategy which provides a better approximation to index. # Define a coherent strategy to combine dynamically stocks and futures according to market data. # Simulate the strategy including transaction costs, rollovers, stop-loss orders, and all other wanted risk controls. # Apply the strategy in the real world using algorithmic trading for signal generation and trying to optimize the P&L, controlling continuously the risks.

Risk management

Systematic trading associates with a number of risks, the returns can be very volatile and funds can quickly amass substantial trading losses without proper risk management. Therefore, systematic trading should take into account the importance of risk management, using a systematic approach to quantify risk, consistent limits and techniques to define how to close excessively risky positions. Systematic trading, in fact, lends itself to control risk precisely because it allows money managers to define profit targets, loss points, trade size, and system shutdown points objectively and in advance of entering each trade. By holding a diversified portfolio of individual systematic trading funds, the high level of volatility and manager-specific model risk can be mitigated.

Systematic Traders

* Perry J. Kaufman, American systematic trader, index developer, and

quantitative financial Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling of financial markets. In general, there exist two separate branches of finance that require ...

theorist.

History

Approach

Risk management

Systematic Traders

References

See also