Trading System Books

One of the common question we often get asked is how and where do we begin to start reading about quant system. Here is a list of books which you must possess to get a grip on this topic. Billions of dollars are trading today on mathematical system. Therefore it may be useful to get these books and start reading and become a expert one day. It is tough but focussed devition for a period of 5 years and reading these books will make you a top trader.

  • Inside the Black Box by Rishi K. Narang - In this book Dr. Narang explains in detail how a professional quantitative hedge fund operates. It is pitched at a savvy investor who is considering whether to invest in such a "black box". Despite the seeming irrelevance to a retail trader, the book actually contains a wealth of information on how a "proper" quant trading system should be carried out. For instance, the importance of transaction costs and risk management are outlined, with ideas on where to look for further information. Many retail algo traders could do well to pick this up and see how the 'professionals' carry out their trading.
  • Quantitative Trading by Ernest Chan - This is one of my favourite finance books. Dr. Chan provides a great overview of the process of setting up a "retail" quantitative trading system, using MatLab or Excel. He makes the subject highly approachable and gives the impression that "anyone can do it". Although there are plenty of details that are skipped over (mainly for brevity), the book is a great introduction to how algorithmic trading works. He discusses alpha generation ("the trading model"), risk management, automated execution systems and certain strategies (particularly momentum and mean reversion). This book is the place to start.
    Algorithmic Trading & DMA by Barry Johnson - The phrase 'algorithmic trading', in the financial industry, usually refers to the execution algorithms used by banks and brokers to execute efficient trades. I am using the term to cover not only those aspects of trading, but also quantitative or systematic trading. This book is mainly about the former, being written by Barry Johnson, who is a quantitative software developer at an investment bank. Does this mean it is of no use to the retail quant? Not at all. Possessing a deeper understanding of how exchanges work and "market microstructure" can aid immensely the profitability of retail strategies. Despite it being a heavy tome, it is worth picking up.
  • Algorithmic Trading by Ernest Chan - This is Dr Chan second book on algo trading. Dr Chan discussed momentum, mean reversion and certain high frequency strategies in great depth. Also provides significant implementation details (e.g. Kalman Filters, Stationarity/Cointegration, CADF etc). The strategies, once again, make extensive use of MatLab but the code can be easily modified to C++, Python/pandas or R for those with programming experience. It also provides updates on the latest market behaviour. We recommend this book as it is as close to getting to real trading examples.
  • Trading and Exchanges by Larry Harris - The book focusses on market microstructure which is an essential part of any form of trading. Without understanding the internal working of a market, it is like going to swim without a trunk and be exposed when the tide dries up. Market microstructure is the "science" of how market participants interact and the dynamics that occur in the order book. It is closely related to how exchanges function and what actually happens when a trade is placed. This book is less about trading strategies as such, but more about things to be aware of when designing execution systems.

    At this stage, as a retail trader, you will be in a good place to begin researching the other components of a trading system such as the execution mechanism (and its deep relationship with transaction costs), as well as risk and portfolio management. I will dicuss books for these topics in later articles.