Quantitative Trading: Edge, Sizing and the Sharpe Ratio

Quantitative trading is a research discipline before it is a trading activity. Most of the work is deciding which ideas deserve testing, testing them without fooling yourself, and turning the survivors into positions that can actually be traded.

How do quant traders find strategies?

They start from a reason. A strategy that works because someone is paid to take a risk, or because a group of investors acts predictably, or because a market structure creates a flow, is more likely to keep working than one found by searching through indicators. The course begins with the reason and treats data mining as the danger it is.

Why does the course give so much time to costs and capacity?

Because a signal with a strong backtest can be worthless after costs, and a strategy that works with a small account can fail at a size that matters. Estimating both early saves months of work on ideas that cannot pay.

How is the Sharpe ratio calculated?

The Sharpe ratio is the most quoted number in trading and one of the most misread. A strategy with a high Sharpe ratio over two years may be lucky; one that sells insurance may look excellent until the year it pays out. This course teaches the statistics and their failure modes together.

Take the average return in excess of the risk-free rate and divide by the standard deviation of returns. To annualize from daily data, multiply by the square root of the number of trading days, which assumes daily returns are independent. When they are not, as in many trend or illiquid strategies, the simple annualization is wrong, and the course shows the correction.

What does the Kelly criterion say?

The Kelly criterion answers a narrow question exactly: what fraction of capital to risk on a bet with known odds so that wealth grows as fast as possible over the long run. Traders do not know their odds, which is why the interesting part of this course is what to do instead.

For a bet that wins with probability p and pays b to one, the Kelly fraction is p minus the losing probability divided by b. For a strategy with expected excess return and variance, the Kelly leverage is the mean divided by the variance. Bet more than this and growth falls; bet twice as much and long-run growth above the risk-free rate falls to zero.

Who is this course for?

Analysts and traders who want the full research process, and students heading for quant research roles.

What you will be able to do

• Write a trading hypothesis with an economic reason and a testable prediction.
• Build, normalize and combine signals across a universe of instruments.
• Turn signals into positions with risk targeting and constraints.
• Estimate transaction costs and strategy capacity.
• Compute and annualize Sharpe, Sortino, Calmar and information ratios correctly.
• Derive the Kelly fraction for a simple bet and for continuous returns.

Syllabus, module by module

1. Hypotheses and edges

   Risk premia, behavioral effects and structural flows; why an edge exists and who pays for it.

2. Signals

   Raw features, normalization, ranking, decay and the information coefficient.

3. Time series and cross-section

   Trading one asset against its own past versus ranking many assets against each other.

4. Combining signals

   Equal weights, regression weights and why simple combinations often win out of sample.

5. Returns done right

   Simple and log returns, compounding, annualization and the risk-free rate.

6. Why sizing matters

   The same strategy at different sizes: growth, ruin and the path between.

What every course contains

Every paid course comes with the first seven and the certificate, whichever level it sits at. The proctored exam and the credential come when the course is taken as part of a Certificate, Diploma or Fellowship. Everything is self-paced: the material is yours to study in any order, at any hour, for the whole of the license.

1. Workbooks. Written to train the thinking patterns and the important concepts of the course, with worked problems and the reasoning behind each answer, so that you learn to think the way the subject is thought.
2. Audio edition. Focused, well-presented recordings with explainers and examples of the material, made to be interesting, relevant and entertaining, so that the general subject can be learned away from the desk.
3. Notes. Pre-produced notes with every fact the course relies on, written out in full, so that nothing has to be transcribed from the films or the audio.
4. Cheat sheet. One sheet with every important learning concept of the course on it, to keep beside you during the work and to revise from before the exam.
5. Named sources. Every fact in the notes names its source, the paper, the book or the dataset, for anyone who wants to dig in further.
6. Explainer films. Focused films, in the style of the sample films on the catalog page, that walk through the most difficult concepts of the course with visual explanations of a high standard.
7. Transcript. A full transcript of every film and every audio recording, searchable and quotable.
8. Proctored exam. Taken as part of a Certificate, Diploma or Fellowship, the course ends in a proctored multiple-choice questionnaire, with a pass mark of 60% and three retakes included. A course taken on its own is assessed by its coursework and has no exam.
9. Verifiable certificate. A certificate of completion that a third party can verify: an employer sends the code on it to the credentials office and receives written confirmation of the course, the date and the result.
10. Credential of the program. The Certificate, Diploma or Fellowship of the program, track or path the course belongs to, awarded when every course in it is passed. Which one depends on the program you choose.

How the certificate is earned

An assessed project: you take one hypothesis from idea to a tested cross-sectional or time-series strategy with costs, and submit the code and a research note in the form a quant desk would expect. On a pass you receive the Course certificate in Quantitative Trading, issued by the Institute with a verification code. A course taken as part of a Certificate, Diploma or Fellowship ends in a proctored online exam with a pass mark of 60%. The fee includes three retakes; each attempt after that carries a reduced proctored exam fee. A course taken on its own is assessed by its coursework and has no exam. Read how certification works.

Before you start

This course assumes the material of the courses below, or the same knowledge gained elsewhere.

• Probability for Quantitative Finance, with Statistics
• Algorithmic Trading Foundations: From Idea to Paper to Live