21 Quantitative Trading Strategies You Can't Afford Not to Know

Every quantitative trader should master the 21 most popular trading strategies covered in this article. These strategies have proven to be key factors used by successful algorithmic and quantitative trading systems, employed not only by individual algorithmic traders but also by established hedge funds and other financial institutions. In this article, we will introduce the basic principles and practical applications of these 21 strategies.

1. Price Momentum Strategy

The price momentum strategy is based on predefined criteria: buying the best-performing stocks and selling the worst-performing stocks. Performance criteria can include cumulative returns, average returns, or risk-adjusted returns. This strategy can be implemented as a long-only approach by establishing long positions in the top 10% best-performing stocks, or as a long-short approach by buying the top 10% and short-selling the 10% worst-performing stocks.

2. Earnings Momentum Strategy

The earnings momentum strategy is similar to the price momentum strategy, also buying or selling the top/bottom 10% stocks based on performance. However, their performance criteria differ. The performance criterion for the price momentum strategy is returns, while the criterion for the earnings momentum strategy is earnings-based.

3. Book Value Strategy

The book value strategy is also based on buying the top winners and selling the bottom losers, but it selects performance indicators based on book value relative to price value (the B/P ratio). The portfolio in this strategy consists of buying the top 10% stocks with the highest B/P ratios and short-selling the bottom 10% stocks with the lowest B/P ratios.

4. Low-Volatility Anomaly Strategy

The low-volatility anomaly strategy is based on the observation that the future returns of portfolios with low return volatility outperform those of portfolios with high return volatility. Although this is counterintuitive because higher risk is expected to generate higher returns, the low-volatility anomaly strategy has demonstrated fairly strong returns.

5. Implied Volatility Strategy

The implied volatility strategy is a trading strategy based on observations of the implied volatility of stock options' puts/calls. The observations indicate that, on average, stocks with the largest increases in call option implied volatility over the previous month tend to have higher future returns. On the other hand, it has been observed that stocks with the largest average increases in put option implied volatility over the previous month tend to have lower future returns. Therefore, based on these criteria, traders can establish long positions in the top 10% stocks with the largest increases in call option implied volatility and short positions in the top 10% stocks with the largest increases in put option implied volatility.

6. Multifactor Portfolio Strategy

The multifactor portfolio strategy relies on buying and selling based on multiple factors, such as value, momentum, and volatility. Therefore, traders can combine uncorrelated factors to improve portfolio value.

7. Pairs Trading Strategy

Pairs trading is a classic mean-reversion strategy and is an example of a pairs trading strategy. The first step in this strategy is to identify a pair of stocks with highly correlated historical performance. The next step is to monitor how the correlation between the two stocks changes over time. When a mispricing is identified, the trader short-sells the overvalued stock and then buys the undervalued stock.

8. Single Moving Average Strategy

A single moving average is a basic trading strategy that calculates a moving average based on the price fluctuations of assets such as stocks, futures contracts, and currency pairs. The logic of this strategy is relatively simple: if the price breaks upward through the moving average, the trader establishes a long position, and vice versa. The strategy can be applied to trading a single asset or multiple assets, enabling long-only, short-only, or long-short trading.

9. Moving Average Crossover Strategy

A moving average crossover is a popular trading strategy that relies on two moving averages: a fast moving average (short-term) and a slow moving average. The trading logic of this strategy is similar to that of a single moving average strategy, but traders focus on the crossover points of the fast and slow moving averages rather than just the market price and a single moving average.

10. Multiple Moving Average Crossover Strategy

A multiple moving average crossover strategy includes not only fast and slow moving averages, but also adds additional moving averages with different durations. Additional indicators can be used to filter out false signals. For example, when the fast moving average crosses the slow moving average, traders wait for a third moving average to cross as well before opening a position, filtering for more reliable signals.

11. Pivot Support and Resistance Strategy

The pivot support and resistance strategy is based on the pivot trading indicator, which determines the central, support, and resistance levels by calculating the average of the previous day's high, low, and closing prices. When the market price crosses above the central level, traders open a long position and close it when the resistance level is reached. Conversely, when the market price crosses below the central level, traders open a short position and close it when the support level is reached.

12. Channel Trading Strategy

The channel trading strategy is based on the channel trading indicator, which consists of two lines that form a band as prices fluctuate. When an asset reaches the bottom or top of the channel, traders short the asset. In channel trading, there are two signal conditions—the price will bounce off the channel, so traders expect it to remain within the channel, or the price will break through the channel, signaling the emergence of a new trend.

13. Merger Arbitrage Strategy

The merger arbitrage strategy aims to take advantage of excess returns generated by corporate actions such as mergers and acquisitions. A merger arbitrage opportunity arises when a publicly traded company attempts to acquire another publicly traded company at a price different from its current market price. This strategy generally has two types—cash mergers and stock mergers. In a cash merger, traders establish a long position in the target company's stock. In a stock merger, traders establish a long position in the target company's stock and a short position in the acquiring company's stock.

14. Market-Making Strategy

The market-making strategy is one of the most popular strategies in algorithmic and quantitative trading. Its operation is simple, like capturing the bid-ask spread of a given trading instrument—that is, buying when buying and selling when selling. However, as with many things in life, there are more details to consider. This strategy relies on the fact that most of the order flow in the market consists of “dumb” money (uninformed retail investors). Although it can work well in some markets, this strategy reaches its limits when it encounters “smart” money (informed investors).

15. Alpha Trading Strategy

Alpha generation is a strategy in which traders attempt to gain an advantage through data mining and machine learning methods. Alpha refers to every trading strategy with a reasonable expected return. These alphas often perform weakly when traded individually, so they need to be combined into an alpha portfolio, also known as an “alpha portfolio” strategy.

16. Arbitrage Trading Strategy

Carry trading is one of the most popular forex trading strategies. It is based on earning profits from interest rate differences between two currencies. The carry trading strategy implies that a high-interest-rate currency should depreciate relative to a low-interest-rate currency. In a basic carry trading strategy, traders sell a currency forward short at a premium (the forward exchange rate exceeds the spot exchange rate), and vice versa. However, this strategy is not risk-free arbitrage because foreign exchange rates may suddenly change, exposing traders to exchange rate risk.

17. Forex Triangular Arbitrage Strategy

Forex triangular arbitrage is a trading strategy based on opening positions in three currency pairs, such as EUR/USD, USD/JPY, and EUR/JPY. The strategy relies on capturing discrepancies between offsetting positions (arbitrage opportunities), where the exchange rate of one currency pair differs from the cross rate between the other two currency pairs. For example, an arbitrage opportunity exists if the result of converting euros into U.S. dollars differs from the result of converting euros into yen and then yen into U.S. dollars.

18. Commodity Futures Contract Roll Yield Strategy

The commodity futures contract roll yield strategy aims to profit from natural contango or futures premiums between the expiration dates of different futures contracts. The strategy generates returns by rebalancing futures positions. When a futures contract is nearing expiration, it needs to be replaced with another futures contract with a later expiration date. If the price of the previous futures contract is higher than the price of the next month's futures contract, spot occurs. Conversely, if the price of the previous futures contract is lower than the price of the next month's futures contract, there is a futures premium.

19. Calendar Spread Strategy

In the commodities futures market, near-month contracts respond to supply and demand more quickly than far-month contracts most of the time. Therefore, traders can implement a trading strategy known as a calendar spread, which aims to profit from the price difference. There are two types of calendar spreads. A bull futures spread is based on buying a near-month futures contract and selling the following month's contract. A bear futures spread is the opposite—you sell the near-month contract and buy the following month's contract.

20. Convertible Bond Arbitrage Strategy

A convertible bond arbitrage strategy is based on convertible bonds. A convertible bond is a hybrid security that allows investors to choose whether to convert the bond from a fixed-income instrument into equity. When the stock price reaches a certain level, known as the conversion price, the conversion occurs according to the predefined conversion ratio between the bond and the stock. A convertible arbitrage strategy is based on buying convertible bonds and short-selling the underlying stock.

21. Sentiment Analysis Strategy

A sentiment analysis strategy is based on using machine learning algorithms applied to social media data to extract trading signals. The process begins by collecting social media posts, most commonly tweets, that contain at least one keyword listed in a glossary within a predefined time range. The second step is cleaning the data. Once complete, the data is further processed using machine learning algorithms to extract models that can be used to predict price movements based on public sentiment.