Why Algorithmic Trading Really Works

Trading is one of the world’s most interesting jobs…

It’s also one of the most uncertain.

My career began in 1991 at Bankers Trust. I remember the head-of-trading’s first words to me. He said: ‘Jason, you’ve made it to this side of the revolving door. The hardest part is staying here.

That was my introduction to trading. You either make money or move on.

The markets have been part of my life ever since. Most of it has been as a trader. I’ve also co-founded a successful stock advisory and fund management business.

Nowadays, I develop and trade my own algorithmic systems. This helps me trade with a level of consistency that I could only dream of when starting out.

Another thing I enjoy is providing the Quant Trader service. Helping everyday traders like you is one of the most satisfying things I do.

People often ask how I got my start. They typically want to know how I became a ‘system trader’ — it’s not the sort of job you hear about at a school careers night.

I also get asked what it’s like to work on a trading floor. Is it really like a scene from Wall Street?

Well, this week I’m going to tell you.

Let me take you back to where it all began…

Level 40

It was the summer of 1991. Australia was thumping England in the Ashes series and Bart had just seen home his eighth Melbourne Cup winner — Kingston Rule.

I remember this time like yesterday. Not so much for its sporting highlights, but rather for the life-changing door through which I was about to pass.

You see, it was two days before my 21st birthday, and I was nervously entering the foyer of the Australia Square Tower in Sydney’s CBD.

Awaiting me on level 40 was my shot at the big time. I was about to start work in the trading room of Australia’s then leading investment bank — Bankers Trust.

Entering the room was like setting foot on a new world. The sprawling area was full of bustle and noise. Some traders had a phone to either ear, others were yelling prices to colleagues.

To say it was intimidating puts it mildly.

This was a group of very smart people at the top of their game. The average salary was said to be higher than anywhere in the country. Bankers Trust was the original millionaires’ factory.

And I soon understood why…

The rewards for success were huge. I remember my bonuses doubling almost every year. There aren’t too many jobs where your pay packet rises so quickly.

There were several departments within the dealing room: Foreign exchange, options, money market, bonds, and futures. My entry role was on the bond desk as a dealer’s assistant.

Now, you might think that traders have a certain personality type. This is true to an extent. But I soon saw it could vary greatly between the trading desks.

For instance, the most raucous in the room were the spot foreign exchange dealers. It wasn’t unheard of for a dealer to smash a computer screen after a bad trade!

At the other extreme was a trading group called ‘Positioning’… 

These guys weren’t loud like the foreign exchange dealers, they didn’t wave their arms about like the futures floor traders, and they weren’t on the phones like the money market dealers.

No, this group was different.

The traders at this desk would sit quietly at their screens. These were the ‘quants’. This small team of about 10 people were one of the bank’s most profitable divisions.

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Rocket science

So how did Positioning make so much money?

I can sum it up with two words: Algorithmic trading.

Positioning’s job was to identify recurring patterns in the markets. Their algorithms, or trading system, would do this by analysing huge volumes of price data.

The group would trade anything from currencies to commodities. Once a trade was on, it was a case of letting winners run and cutting losses — just like Quant Trader.

These guys weren’t like most traders. They had no time for gut feel, and they didn’t crave an adrenalin rush. Every trade had a statistical underpinning.

And this struck a chord…

You see, I’m a bit of an introvert. The thought of yelling across a busy room didn’t thrill me. I’d much rather crunch the numbers on a new trading system.

Algorithmic trading wasn’t like anything I’d seen before. Forget the seat-of-your-pants stuff. This was all about using a computer to consistently identify high potential set-ups.

I’d describe algorithmic trading as a ‘thinking’ trader’s strategy.

I’ll tell you what I mean…

I remember listening to the head of Positioning talk to a colleague. He was explaining how he could statistically prove that stock markets move in trends.

And he wasn’t just saying this. I saw him put his strategies into action.

It was the early 1990s, and Australian interest rates were falling. The dealing room had a huge bet that rates would fall further at the next Reserve Bank of Australia (RBA) meeting.

Sure enough, rates fell — big time.

The RBA cut rates by more than the market was expecting. The dealing room was up $10 million dollars that morning alone. This was a huge amount of money back then.

Senior management was anxious that prices may pullback. Their go-to man was the head of Positioning. They gave him the job of using his statistical edge to decide when to cut the trade.

The outcome by day’s end was a massive $15 million win. To put this into perspective, Westpac’s profit in 1991 was $476 million — or $1.3 million per day.

I was hooked. It was an introduction like no other.

There was no doubt in my mind: Algorithmic trading was a gold pass to make a lot of money.

My transition to fully-fledged system trader would take time. I had a lot to learn about markets before I could start designing my own trading systems.

But I was in the perfect place to develop my skills. The opportunity before me was huge.

People talk about being in the right place at the right time. They say good fortune can happen to you by accident, simply due to your timing and location.

Well, that’s true of me to an extent…

I didn’t know Bankers Trust was an algorithmic pioneer when I first got a job. My early exposure to systematic trading was purely by chance.

Maybe I would have been successful at another bank. I’ll never know.

But I can say this: I’m the trader I am today due to algorithms — they’re by far the greatest find of my career. Hopefully, I can help you benefit from them like I have.

Until next week,

Jason McIntosh,
Editor, Quant Trader

Editor’s Note: Professional trading rooms are a mystery to many people. The banks and hedge funds that operate them are notoriously secretive and highly selective about who enters their realm.

But you have an in…

Jason McIntosh’s Quant Trader is a fully algorithmic system for detecting and profiting from big trends in ASX stocks. You get to experience the style of trading that’s made millions for some of the best trading firms.

This could change the way you trade. Check it out today.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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