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This blog post originally appeared on RealMoney Silver on March 12 at 9:24 a.m. EDT.

There was an interesting article a few days ago in The New York Times titled " They Tried to Outsmart Wall Street." In the article, the author discussed Wall Street "quants." To many, they are a mysterious group, right out of the cast of the Revenge of the Nerds series of movies. To me, they are like kin.

You see, I went to Stuyvesant High School where the biggest teams were the math, chess and debating teams. I think we had a football and basketball team, but they were more elusive than quarks. The school prides itself in having graduates go on to win the Nobel Prize (four!) rather than the Heisman Trophy.

When it came time to go to college, my mother's side of the family -- all of who are Ph.D.s, one of which is a Nobel finalist (I cannot disclose his name), another who could have won the award had he not passed away recently -- expected me to get my Ph.D. in mathematics. Realize that at this point in my life, my father had passed away, and I had the taste (and the need) for the wonders of capitalism. I did not see any mathematics stores at the mall, and despite my father wanting me to become an actuary, I felt there was more to life. I wanted to have some fun. Hence I went to the Wharton School and began a career in accounting and finance. Now L'Hopital's rule is but a fond high school memory.

As I progressed through the world of finance, I always came into contact with "quants" and in fact was part of Nunzio Tartaglia's and Gregg van Kipnis' group at Morgan Stanley ( MS). These gentlemen are the founders of "black box" computerized pair and cluster trading system that still exists today across the hedge fund world. I was counterparty to Long Term Capital Management when I was head of the equity swaps desk at Merrill Lynch. While I was respectful of the bright minds at LTCM, I was also acutely aware of their lack of knowledge of the equity markets. I was the first and only person at Merrill to finally refuse to do business with LTCM and had no positions at the time of the hedge fund's fall.

One time a physics professor built a quant trading model he wanted to "sell" to Kipnis and our team (by then we were at County NatWest). We had the professor's Ph.D. candidate come into the trading room to test the model. We plugged it into our Sun Sparc station and fired up the program. It spit out a pair to trade: long stock A; short stock Z. A few minutes later the Ph.D. candidate asked how we were doing with the trade. We said we could not do the trade. He asked why. We said because we could not get the short off, as there was no uptick (remember what that was?) He asked what an uptick was. We closed the computer and took him to lunch. Enough said.

There are several problems that "quants" face when trying to conquer the thundering herds of bulls and bears on Wall Street. Quant trading models broke down in 2008 for many reasons. Here are some:
  • They have no exit strategy. They understand how to enter a position but usually have no plan how to exit a position.
  • Human emotions and psychology are often ignored or considered a constant.
  • The downside is not often considered because the model says it won't occur in a "perfect" world. Unfortunately, the world is not perfect and does not exist in a vacuum.
  • Companies are looked at as static models, while stocks are looked at as variables. Anyone who follows the stock market knows that companies are not static -- earnings, balance sheets, managements, products and other financial metrics are constantly changing.
  • They never traded a stock in their life.
Frankly, I think that you can achieve excellent statistical returns by using simpler methods that remediate many of the quant problems I just listed. So before you choose to go down the path of hiring a quant to manage money or work for you, think twice. Instead, perhaps you can just relax and watch one of my favorite shows, Numbers.


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At the time of publication, Rothbort had no positions in the stocks mentioned, although positions can change at any time.

Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele. He also is the founder and manager of the social networking educational Web site TheFinanceProfessor.com.

Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.

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