Best of 2010: The Quants by Scott Patterson

The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It, by Wall Street Journal reporter Scott Patterson, is the inside baseball story of the quest for The Truth on Wall Street. That is, the fountain of money that never stops flowing.

-- As made manifest from the odds, the probabilities.

-- As interpreted by the "quants," traders who believed, above all else, in the numbers, data, statistics.

And why not? That's not immediately pejorative, though Wall Street has gotten a very, very bad reputation of late. After all, odds, probabilities, are the stuff of everyday life. We don't think about them consciously. But they're there. You and I cross the street -- now -- because we see the odds of getting hit are nil. We didn't cross 10 seconds ago because we saw two semi's roaring towards us. We don't even think about these as "probabilities," per se. But they are. And for those who do think about probabilities, and in connection with financial markets, from a vast resource of education (preferably Phd) and erudition and experience, the rewards can be staggering, as in a million per minute.

Quant trading started in -- wait for it -- Las Vegas, where odds-making (not image, sorry Andre, our favorite LV homebay) is everything. This is where card counting got its start. Card counting is just probability analysis, on the fly. And card-counting, writ large, is quant trading. Card counting pioneer, Ed Thorp, was the progenitor of quant trading. Thorp begat Ken Griffin, Citadel. And on and on it went (and goes).

Some of the other featured players here include:

• Cliff Asness, Goldman Sachs, Global Alpha, group leader, and founder AQR
• Boaz Weinstein, Deutsch Bank
• Peter Muller, Morgan Stanley

Author Patterson wields a deft pen, and never fails to grab the reader at the end of a section or chapter: you have to keep reading. Very entertaining. To peel back the layers of secrecy and expose the histories, successes, failures, personal peccadilloes -- the whole story of 'the quants' -- is a very great journalistic accomplishment. THE QUANTS is not an indictment, per se, of the entire enterprise of quantitative trading, but does indict extreme leverage and the perils it presents. Interestingly, Patterson follows the founder of the practice, Ed Thorp, who turns away from over-leverage, and generates excellent returns without it.

So, as per usual with Wall Street, we come back to the question of greed. Greed is good? Maybe like alcohol or fire or nuclear energy? A little bit, the right place, the right time. Managed. To overdo here is to destroy, and the problem is, we're all on the hook for it. THE QUANTS is big, intriguing, messy, clear, ambiguous, and provocative -- just like the financial industry it covers. It is, quite simply, a must read.

PS: Talk about "destroying Wall Street", as we were reading this volume, the Dow experienced the infamous May 6, 2010, "Flash Crash," for which many explanations have been offered, but the truth? We are still waiting; Wall Street doesn't tell all its secrets, not even to Mr. Patterson. As author Patterson wraps it up: "here come the quants." Indeed.

PPS We received from a Chicago quant this youtube.com video. Another cautionary quant tale, a good one, told in large part by a quant-turned-oysterman (he lives off his interest) and we recommend it to you:

Quotable:

• "Beauty is the right level of complexity."
• "Condensing 300 pages of prose to one equation = beauty to a mathematician."
• "A major rethink is required if the world is to avoid a major mathematician-led market meltdown."