Rational Quantitative Trading in Efficient Markets
67 Pages Posted: 21 Dec 2009 Last revised: 24 Oct 2020
Date Written: August 25, 2019
We present a model where quantitative trading − trading strategies based on the quantitative analysis of prices, volumes, and other asset and market characteristics − is systematically profitable for sophisticated traders whose only source of private information is knowing better than other market participants how many fundamental traders, i.e., traders informed about fundamentals, are active in the market. In equilibrium, the direction of optimal quantitative trading depends on the number of fundamental traders and often switches sign when order flow increases: with few fundamental traders, optimal quantitative trading is trend-following (re. contrarian) after small (re. large) price changes; with many fundamental traders, the opposite holds: it is contrarian (re. trend-following) after small (re. large) price changes.
Keywords: Quantitative trading, Uncertainty about informed trading, Market efficiency, Learning
JEL Classification: G12, G14, D82, D84
Suggested Citation: Suggested Citation