Assessing High Return Claims in Algorithmic Equity Trading

# What kind of return can an average algorithmic trading firm achieve today?


# What kind of return can an average algorithmic trading firm achieve today?












What kind of rate of return can an average, equities-focused algorithmic trading firm expect to achieve today?

I come from a background of control and optimization, working in the industry in China, but I also work with a team to do investments and trading on the side.

In our market, which has a very different set of rules, it seems that the most profitable investment strategies are medium-term in time horizon. The yearly rate of return, for skillful private investors with several million USD, can be about 50% or so, but this number does, of course, vary from year to year.

Recently a trader working at an investment bank, with a mixed background working with investment funds and as a quant developing high-frequency trading models, tried to persuade us to try algorithmic trading in the western markets.

He claims that with several million USD's investment he can achieve a yearly return rate of 100% in the US stock market with the strategies he developed recently.

I just want to know if this is possible? I know his algorithm is quite different than those that can be found in the published journal papers on finance.

Although this seems to be OK (I doubt any good strategies will ever be published and we sure won't publish ours), but he failed to explain his strategies in much detail. From his point of view this is understandable, but it has certainly created a lot of doubt on our part.

One detail I learned from talking with him is that his method involves event-driven trades and requires a lot of text-mining.

## Answer by Matt Wolf (score 10, accepted)

https://quant.stackexchange.com/a/4537

Whether its possible? Absolutely. However, you should probably keep in mind a couple points:

* Many people claim a lot while proving very little to none. This is fine if the issue is a small-talk conversation. Believe it or not, no harm done. However, this is about money, and from my experience I cannot stress enough how important it is to do a very intensive due diligence on your part. Ask him to prove that he is worthy of your investments. Ask him for audited broker statements which detail his past trades so that you can build a more credible risk/return profile and see whether the statistical results speak in favor of funding him. Ask him to somehow send you live execution notifications of his currently live running strategies. Its very simple to code up a small application, especially for people active in algorithmic trading. If he rejects to show any sort of proof or verification then I would be more than careful.

* Should you ever invest with him then I recommend you make sure your funds are segregated from any other of his funds. Its very simple in a professional "umbrella fund structure". You basically open an account in your own name while giving him trading authorization in your account. In that way he is unable to withdraw or transfer funds out of your account.

* Keep in mind China is still a very inexperienced wild-west market in terms of financial investments. I say this because I spent almost my entire career in East Asia, Tokyo, HK, Singapore, Shanghai, now Tokyo. Chinese investors are a very special kind of breed when it comes to investments. Most are still having completely irrational expectations. They want a guy to generate 50% return, if at year end he generates 45% then they kick him out, and move all their money overnight into real estate. Then when the real estate market cooled down they moved all their funds into commodities and gold, and such forth. There is no loyalty, no trust, no nothing in China when it comes to investments. Expectations of achievable returns are exaggerated and so are promised by those who manage funds. Thus, I would be very careful about claims of someone able to generate 100% returns. Its doable, sure, but the risk of blowup grows exponentially, and the draw downs in between may be a lot larger than you can stomach. Do you feel comfortable waking up one morning and reading in your email inbox that your investment overnight tanked by 15-20% just because your fund manager concentrated all in that "hot" stock that he got some secret tips about and invested in? Be my guest, but I would ask very hard and potentially challenging questions in terms of what his thoughts are on risk/reward. If I speak to someone managing money and he mentions "returns" earlier than "risk" then he is OUT, SIMPLY OUT. Believe me, someone who promises you something without first mentioning the risk behind it should be avoided int his particular industry. Why all those comments about China and Chinese investors? Because I get the sense that you also have slightly unrealistic expectations of achievable returns within the framework of sane and sound risk management. If you get all crazed up by someone promising 100% then something is wrong, or do most people get excited when they watch a telemarketer on TV promising that the USD 3.99 gem can really heal sicknesses? My advice to you: Be realistic what to expect. The US stock market is not the Chinese real estate market 10-15 years ago.

Take my advise or leave it, its your choice, but I would be very careful about someone who says he can generate 100% returns. It sounds extremely fishy and unprofessional.

Good luck!!! (i hope you dont need it)

P.S.: After I finished writing this and read your question again, I smirked, then shrugged, then felt pain. I actually recommend you to run, do not invest with such person, I am almost willing to bet (not the farm but a significant amount) that currently its close to impossible to generate 100% returns on a significant investment in US stocks on event based strategies. The probability of me being wrong is probably somewhere between 0.02%-0.5%. Just my 2 cents.

## Answer by SRKX (score 5)

https://quant.stackexchange.com/a/4536

You will struggle to put a number on the potential returns of high-frequency trading (HFT) and I think it wouldn't make any sense anyway if you don't take into consideration its risk and its leverage. Achieving 100% return with low volatility seems highly improbable; so ask the trader in question his Sharpe ratio to start with and compare it with yours.

From a more economical - or even philosophical - point of view, you can notice that, to trade at higher frequencies you need to invest more money in sophistication of your trading form. Moreover, I believe this cost will look more exponential than linear.

So the question might be is there a payoff in the markets for this kind of sophistication?

I think the answer to that is yes, because by getting to higher frequencies, your are able to trade different kind of strategies and different kinds of events. According to the efficient market hypothesis (EMH), inefficiencies should disappear instantly as market participants notice them. So, the fewer participants you have at a higher frequency, the better the chance you'll have to get a large piece of the cake.

Note: you can do algorithmic-trading at a lower frequency as well, but then my point above is not really valid anymore, although it is still about payoff for sophistication

## Answer by Charlie (score -1)

https://quant.stackexchange.com/a/68316

It is absolutely possible for an HFT to make those returns as a developer I am well aware of those methods. If the guy has the right background totally possible as I have built strategies in the proper language that have even exceeded that. His algorithm isn't as black box as most would expect you just have to know where to find the information and what is useful in building said system have the right background and having interned and worked at some of the biggest names in the space and the specialization required to implement it isn't for the average person.