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Gregory Zuckerman: The Man Who Solved the Market

Jim Simons and quant investing

Jim Simons has emerged as a modern-day Medici, subsidizing the salaries of thousands of public-school math and science teachers, developing autism treatments, and expanding our understanding of the origins of life.

The man who solved the market

In the fall of 1990 after 12 years Simons maybe found together with Elwyn Berlekamp a computer model, able to digest enormous amounts of data and found best trades. A scientific and systematic approach partly aimed at removing emotions from the investment process.

Berklamp left and Simons brought two scientists from IBM on board Robert Mercer and Peter Brown.

There are patterns in the market and I know we can find them, was moto of Simons.

Money isn’t everything

The way that powerful theorems and formulas could unlock truths and unify distinct areas in math and geometry captures Simons.

Simons get in touch with trading at Merrill Lynch. But he stayed at university for some time, but a seed was planted. Simons loved mathematics, but he also needed new adventures.

In 1964, Simons quit Harvard University to join an intelligence group helping to fight the ongoing Cold War with the Soviet Union.

The IDA taught Simons how to develop mathematical models to discern and interpret in seemingly meaningless data. He began using statistical analysis and probability theory, mathematical tools that would influence his work.

Around that time, Harry Markowitz was searching for anomalies in securities prices, as was mathematician Edward Thorp. Simons was part of this vanguard. Their model foreshadows revolutions in finance – including factor investing, the use of models based on unobservable states, and other forms of quantitative investing.

By 1977, Simons was convinced currency markets were ripe for profit. World currencies begun to float, moving freely without regard to the price of gold.

Simons had been a star cryptologist, had scaled the heights of mathematics and had built a world-class math departments, all by the age of forty. He was confident he could conquer the world of trading.

Simons decided to treat financial markets like any other chaotic system. He would build mathematical models to identify order in financial markets. He named his new investment company Monemetrics. His partner was Leonard Baum, one of the co-authors of the IDA research paper.

Baum together with Lloyd Welch developed an algorithm to analyze Markov chains. In a Markov chaing, it is impossible to predict future steps with certainty, yet one can observe the chain to make educated guesses about possible outcomes. The Baum-Welch algorithm gets you closer to the final answer by giving you better probabilities.

Some investors liken financial markets, speech recognition patterns, and other complex chains of events to hidden Markov models.

Simons also bring in James Ax. They used Baum algorithm to trade not only currencies but also commodities. For programing they brought in Greg Hullender, but he was gone quickly.

In 1982, Simons changed Monemetrics’ name to Renaissance Technologies Corporation.

Simons had to find a different method to speculate on financial markets; Baum’s approach, reliant on intellect and instinct, just didn’t seem to work. It also left Simons deeply unsettled.

Instead of Hullender they brought in Sandor Straus. He started to develop huge database with a lot of information. Straus’s data helped Ax improve his trading results.

Ax and Straus set up their own company Axcom Limited and Simons owned 25 %.

Stochastic equations model dynamic processes that evolve over time and can involve a high level of uncertainty. It’s easy to see why they saw similarities between stochastic processes and investing.

For much of his life, the suggestion that Elwyn Berlekamp might help revolutionize the world of finance would have sounded like someone’s idea of a bad joke.

Berlekamp joined and he and Ax didn’t get along. He urged Ax to look for smaller, short-term opportunities. Berlekamp said that Ax was a competent mathematician but an incompetent research manager.

Simons launched new hedge fund with AX called Medallion. Berlekamp bought Ax stake in fund. He also took the reins of the Medallion in 1989.

He moved to short-term trades. If you trade a lot, you only need to be right 51 percent of the time. In 1990 Simons bought out Berlekamp.

Simons approach wasn’t that new. The technical analyst were the “forerunners” of quantitative investing. In the 1970s, a Berkley economics professor named Barr Rosenberg developed quantitative models to track the factors influencing stocks. Edward Thorp became the first modern mathematician to use quantitative strategies to invest sizable sums of money.

Morgan Stanley created ATP (Automated Proprietary Trading) group. By 1987 they were generating 50 million of annual profit. David Shaw and Robert Frey were part of that group. Frey later joined forces with Simons. Shawn created his own fund. And Bezos worked for him for few years.

With competition growing, Medallion would have to discover new ways to profit. Simons turned to Henry Laufer. Laufer made a choice to use single trading model for all types of investments. They also added new people like Kresimir Penavic and Nick Patterson.

In 1996 Straus sold his Renaissance shares and quit.

Simons wanted to expand, but the only way to do it, was stocks.

Named after William F. Sharpe, the Sharpe ratio is a commonly used measure of returns that incorporates a portfolio’s risk. A high ratio means stable historic performance.

Patterson invited Peter Brown and Robert Mercer from IBM to join. They tried to solve Simons dilemma of stock trading.

They needed a help from another IBM staffer David Magerman.

Simmons emphasized several long-held principles. Scientists and mathematicians need to interact, debate, and share ideas to generate ideal results. Medallion would have a single, monolithic trading system. Peer pressure became a crucial motivational tool.

In 1998 some quantitative funds lost a lot. Patterson says that the problem was that they believe their models are truth. He said that they never believed their models reflected reality, just some aspects of reality.

In 2002, Simons increased Medallion’s investor fees to 36 percent and a bit later to 44 percent. Later he started to kick out all investors. He worried that performance would ebb if Medallion grew to big.

One new employee was Alexey Kononenko. Patterson was out. Company was changing. Two important employees Belopolsky and Volfbeyn announced they are moving to competition in 2003. They were joining Millennium Management. And they were talking business secrets with them. The firm was thorn in two due to a different view on Kononenko. Simons had to do something about everything.

Stepping down from Renaissance gave Simons more time on his 220-foot yacht Archimedes. He was worth 11 billion.

Mercers were backing up politics and they get involved with Steve Bannon, that brought them to Trump. They were also involved with Cambridge Analytics.

On the other hand, David Magerman, who left the company once and come back, was not happy with Mercer’s view and share his story with newspaper. He was fired by Renaissance.

Simons realized that Mercer’s involvement in politics is hurting Renaissance in 2017 and he agree with him that he would step down as CEO.

Today quants are getting new normality and Simons approach is used by everybody, with all the digitized information around.

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