Wednesday, September 14, 2011

Schmidt, Financial Markets and Trading

Anatoly B. Schmidt’s Financial Markets and Trading: An Introduction to Market Microstructure and Trading Strategies (Wiley, 2011) would never be subtitled “markets for poets.” (I wrote this lead sentence before I realized, double-checking Schmidt’s credentials, that an earlier book of his was entitled Quantitative Finance for Physicists.) Schmidt has a Ph.D. in physics, is a quantitative analyst, and teaches in the financial engineering program at Stevens Institute of Technology.

This book is not for the math shy. Most of the math is relatively straightforward, but there’s a lot of it. For instance, in the chapter on technical trading strategies Schmidt discusses some popular technical indicators and chart patterns, always with formulas prominently displayed. While I personally think it’s important to know how technical indicators are constructed, there are a host of other sources for this information.

For those who can read formulas as easily as sentences, Schmidt’s book offers a good survey of the academic literature on market microstructure (inventory models, information-based models, models of limit-order markets, and models of empirical market microstructure) and market dynamics (statistical distributions, volatility, and agent-based modeling) and describes some trading strategies (technical and arbitrage) and back-testing procedures.

Personally, I found the section on market microstructure the most intriguing—and since, I somewhat sheepishly admit, I skipped most of the math, I had mighty little to read. Here are a couple of takeaways.

A buyer (seller) is more likely to submit a market order if there is a thick limit order book (LOB) on the bid (ask) side. A buyer (seller) is more likely to submit a limit order if the LOB is thick on the ask (bid) side. (p. 52) (These points may seem intuitively obvious, but how many at-home traders adjust their order types according to supply and demand pressures?)

In the past, intraday U.S. equity trading volumes were U-shaped. Since 2008 the volume pattern has become closer to J- (or even reverse L-) shaped. (p. 59) That is, volume peaks at the end of day.

Readers who are comfortable in the world of quantitative finance will learn much more than I did. Not that this is a groundbreaking book. It is best viewed as a textbook for would-be financial engineers.

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