Last September, I told my clients I was going to take a break, that they should enjoy the long positions we had accumulated. I gave them PowerTools and took off to do the R&D that needed to be done to ensure future performance.

I had been trading for two decades, and to be honest, it was getting boring. Really boring. From the day I met The Quant in the mid-90s, I knew the time would come to take up a new challenge, to expand one’s professional horizons in a serious way. Doctors and dentists call this process professional development, but in my mind, what I was about to do was closer to what economists call creative destruction. Much closer.

In any profession, there is a learning curve. It is analogous to the S curve. [Excellent study case here] For those who manage to get close to the top, it becomes incrementally hard to improve because there are really no more incentives to do so. Some rest on their laurels. Others become retarded at the moment of fame.

For me, the decision was easy: find a new curve to climb. I had accumulated too many questions that only number-crunching could answer. I just wanted to know more, to investigate things to satisfy my intellectual curiosity. I needed schooling in quantitative methods. Simple as that.

I started life as a scientist, and somehow ended up a discretionary trader. Talk about massive cognitive dissonance. On one hand, I was trained in the scientific method. On the other, every trader I met in my day used discretionary methods. Even though I knew that short-term, pattern-based trading is mostly a mind-reading exercise, it bothered me to rely so heavily on subjective judgment that focused mostly on the “when”.

What about issues pertaining to trade logistics where good judgment can’t really help us in real-time? Humans are definitely not wired to calculate these things tick by tick, and as such, quantification is useful and necessary when we are trading on the fly.

• How much margin can I use?
• How many shares should I trade?
• Where should I place my stop?
• Should I press the winners? If so, when?
• How do I build and trade an entire portfolio?
• How do I measure and manage risk?

While making more money is the obvious motive, answering these questions produces even more benefits. For example, my trading program is shaped by ongoing R&D, but during market hours, I simply execute the plan. I don’t have to make any decisions. I just manage the risk.

Another area where quantitative stuff is particularly useful is in portfolio construction. There is a great tendency for discretionary market strategists to do three things, 1. avoid sectors that are “overheated”, 2. chase performance, and 3. go against the tide too early. These are serious issues for traders as well.

In the first instance, one misses a huge opportunity to make money. In the second instance, one repeatedly buys high and sells low. In the third instance, one finds out that the light at the end of the tunnel is that of the on-coming train. Needless to say, these mistakes tend to compound and takes a huge toll on the bottom line. As usual, it is the clients that pay big time and there is no reason why they should. This will be the subject of my next article: the difference between an asset manager and an asset gatherer, and the underlying assumptions that make this topic 100% relevant to traders.