Quant Trading: A Victim of Its own Success

Asad Dossani

Quant trading strategies have many advantages. For one, they are easy to implement. Once a strategy is in place, you trade based on a set of rules. A simple quant strategy could work like this: Buy when the price is above its ten-day moving average. Sell when the price is below its ten-day moving average. Trading this strategy is as easy as it gets.

Another advantage is the ability to backtest a strategy. With historical data, you can test how your strategy would perform had you implemented it in the past. Then you can select only the best performing strategies. Quant trading is objective. Since you trade only on a set of rules, emotions are out of the equation. There is no panic buying or selling.

Finally, quant trading is easily scalable. Once you create a strategy, you can apply it to other markets and timeframes. And since quant strategies are based on historical data, you don't need to worry about different fundamentals across markets.

Unfortunately, quant trading is falling victim to its own success. We've seen an explosion in the use of quant trading strategies in recent years. This is true for individuals and institutions.

What happens when more and more people use quant strategies? They stop making money.

If enough people use the same strategy, it ceases to be profitable. And this is exactly what's happened to many quant strategies. Particularly the simple ones. If you backtest the moving average strategy described earlier, you'll see a familiar pattern. It performs well historically, but not in the last couple of years. Many quant strategies fail to perform on recent historical data. And this is precisely because too many people are using them.

You may be wondering, why doesn't the same apply to fundamental analysis? Value investing has been around for decades. But its profitability hasn't been eroded. Why? It's because quant trading requires much less effort to scale.

If I want to apply an existing quant strategy to a different stock, it's easy to do. The rise of computing power means I can test the same strategy across hundreds of stocks. But with value investing, I must put in effort. Each stock I analyse requires time and resources. Its costly to scale, unlike a quant strategy.

How should a trader respond?

By employing the best of both worlds. Using quant and fundamentals together can give you an unbeatable edge. In my latest course on derivatives trading, I show you how to do this. How you can apply profitable strategies to the derivatives markets. It's a fantastic opportunity to learn and earn at the same time.


Market Notes

The Rollover Data Suggests Range Bound Trading

Unlike the past few expires when the Nifty 50 Index ended at new highs, the June series expiry ended 2% below its life high.

Last time, in our May expiry rollover report, we saw higher-than-average rolls but open interest (OI) declined in absolute terms and the Nifty rallied 1.8% for the expiry. A rising index with decreasing OI suggested a short covering rally. This means the OI that had built during the decline faded away by the rally in the index, indicating that the bears were out of the market for the moment. And as a result, the index showed strength during the initial days of the June expiry and touched a new life high of 9,709.

But the bears dominated in the last week of the expiry as the index slipped to end the June expiry on a flat note. Let's see what the rollover data suggest this expiry.

But first, what is rollover?

Rollover refers to traders shifting their future positions from the near-month contract to the next-month contract. For example, Nifty traders are shifting their future positions from the June expiry to the July expiry. Here's the formula:

Rollover % = Next Month OI (M2)
Near Month (M1) + Next Month OI (M2)

The rollover formula tells the percentage of contacts rolling into the July expiry from the total contracts outstanding from the June and July expiry.

This month, Nifty rollovers stood at 72%, which is higher than the previous three-month average of 68%. Open interest (OI) was 2.03 crore compared to 2.00 crore in the previous expiry. Open interest in absolute terms increased marginally and the rolls were on the higher side.

In the initial days of the expiry, the index rallied and the OI increased during this rally. After that, the index and the OI remained flat until last week of the expiry when the index declined sharply with OI increasing. But finally, the OI outstanding on the day of expiry was unchanged from the previous expiry.

The Nifty Index also remained unchanged at the end of the June expiry. Although we saw higher-than-average rolls, the absolute OI data gave us no clear indication.

Nifty Options Matrix (Open Interest)

On the options front, the Nifty put-call ratio (PCR) stood at 1.14. This means put open interest is higher than call open interest. Being a contrarian indicator, a high PCR reading is generally favourable for the markets.

The 9,700 strike call has highest built-up with 27.15 lakh OI. And 9,400 strike put has highest built-up with 41.61 lakh OI. Based on this, 9,700 can act as resistance and 9,400 as support in the July expiry. As seen in the chart above, the 9,400 put has strong OI outstanding. This level might act as a major support for the index in the July expiry.

At the end of April expiry, the 9,000 put and 9,500 call had the highest OI. This shifted upwards to 9,300 put and 9,600 call at the end of May expiry. But this has again shifted up to 9,400 put and 9,700 call at the end of June expiry, which favours the bulls.

Now let's look at the Nifty chart. The index traded on a volatile note during the June expiry. It shot up 200 points during the start of expiry to a high of 9,709. It corrected 150 points during mid-expiry and then bounced strongly to retest its life high. But in the last week of expiry, the bears dominated and the index again slipped 150 points.

Towards the end of the expiry, the index broke below its 20-day exponential moving average (EMA), which has acted as strong support since January. The RSI indicator also broke below 50, which had acted as support during declines. This indicates a bit of weakness in the near term.

Nifty Index Traded Volatile for the Expiry
Aurobindo Pharma Rallied 13% for the Day 

The rolls were on the higher side, but the OI and Nifty ended the expiry flat, providing us no clear view. But the PCR data seems quite encouraging. Since the 9,400 put has strong OI outstanding, the bears will need a serious commitment to push the index below his level.

But the bulls will also need to do some work to get back in action. They need to push the index above its 20 EMA for the price action to confirm strength.

Until a serious commitment of either bulls or bears, we can expect the index to trade in a range for the coming expiry.

From The Market Wizards...

"A good trading rule is to be long the strongest when long and short the weakest when short." - Peter Brandt

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