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Quantitative investing is the process of choosing potential investments based purely on statistical measurements. These statistics can measure both the worth of an investment security and the way it has behaved on the market in the past, in an effort to predict future performance. Most quantitative investing is done with the use of intricate computer models which can digest large amounts of information and come to conclusions about which investments should be made and which should be avoided. It takes the human, psychological element out of investing, but it can also be disadvantageous if the model used fails to account for sudden, unexpected events.
As computer technology has changed practically every aspect of modern life, so too has it affected investing. The use of quantitative trading methods was first pioneered by hedge funds which were historically available to only the wealthiest investors. These strategies have now filtered down to other funds and even to individual investors. Quantitative investing is the chosen strategy of those investors who choose to put their faith solely in the numbers.
Computer models, which can process large amounts of data in a far quicker and more comprehensive fashion than human investors, are at the heart of most quantitative investing strategies. The models take in all of the pertinent information and then spit out very basic commands to the investor, indicating whether a stock should be bought or sold. As a result, any gut feelings or psychological prejudices that a human investor might bring to the table are weeded out by this process.
Some quantitative investing strategies focus on the value of the securities in question. Such strategies attempt to find the intrinsic value of securities in an effort to see if they are being overvalued or underrated by the market. Other investors who use quantitative methods, also known as quants, follow models designed to indicate price trends. This practice of trend following can discern if a certain security is due for a spike in price based on how it has been performing in the recent past.
There are limitations to quantitative investing which any investor planning to explore the practice should be cognizant of. A specific strategy is only as good as the model on which it is based, so investors should check out the track record of the predictions made by any quantitative model. In addition, some less-advanced quantitative models take a long time to react to significant changes in the market. By the time these slow-reacting models adjust to an unforeseen event, the damage done to an investor following their advice can be serious.