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Data-Driven Traders Begin To Dominate Financial Markets


Robots and algorithms are playing a bigger role in many parts of our lives, from transportation to medicine. A major series in The Wall Street Journal looks at their role in investing. Investors who rely on algorithms now control about a third of all trading on U.S. stock markets. Gregory Zuckerman is a senior reporter on this series called "The Quants," and he joins us now. Welcome.

GREGORY ZUCKERMAN: Hey, great to be here.

SHAPIRO: What is a quant?

ZUCKERMAN: So a quant is an investor who relies, instead of instincts and kind of old-school methods to figure out where a stock's going - instead, they rely on algorithms. They rely on everything - computer models, mathematical means. Basically, it's a way of taking the human element out of it, to some extent. And like the rest of society, as you kind of suggest, there's more of reliance on that method than ever before.

SHAPIRO: And what can a quant do that an old-fashioned trader can't?

ZUCKERMAN: Well, to me, what they're trying to do is kind to address some of the issues raised by behavioral economics, in that we make mistakes as investors. And they're trying to take those away, the things like selling at a high, getting excited about an investment when you shouldn't and taking out human emotions and other kinds of things that have brought us down as average investors in the past.

SHAPIRO: A lot of us who are not big-time investors have our money in index funds, and a lot of that is automated anyway. So is - is that different from what you're describing in "The Quants"?

ZUCKERMAN: Well, index funds are automated to the extent that they invest and they buy a broad swath of stocks. And there's a formula that governs how they invest. But these are investors that make thousands of investments a week, if not a day. And they do it in a different way. They're just not buying kind of broad indexes, broad swaths of the market. They're making individual bets over and over again. So they're much more complicated, more sophisticated, and they do it in a - in a more potentially dangerous way than the average index fund.

SHAPIRO: You write about companies with financial dealings that have become so complicated that no human can actually figure out how the company's finances work. It has to be done by computers. What does that mean for oversight and regulation? Does that make it harder to avoid a future financial crash?

ZUCKERMAN: Quantitative investment firms are more prominent, and money is flowing to them. But in some ways, they're still black boxes. And for investors - and we're talking about pension funds, insurance companies, charities - that are plowing money into them, they're in a quandary. On the one hand, they've done quite well, and it makes sense.

As all of society is becoming more automated, as big data is embraced, left and right, as we all become a little bit overrun by all the data that's thrown at us, it makes sense to shift to quantitative-type investors. And yet they are hard to figure out. They are black boxes. It's not clear what their factors are, what the signals, as they call them, are that govern a lot of investing. So it does suggest that the markets are becoming much more complicated and harder for outsiders to analyze as quants become much more prominent on Wall Street.

SHAPIRO: Well, it's not just that they're black boxes because people are trying to keep secrets. It's that they're black boxes because they're so complicated, even the people who run them don't totally understand how they work.

ZUCKERMAN: Yeah, it's fascinating. There's a firm called Renaissance Technologies, and they are the preeminent firm and have been for decades. And even in this world, the Ph.D.s at rival institutions have no clue how they make so much money, and they scratch their heads. So if even the Ph.D.s can't figure it out, it's that much harder for regulators and for average investors.

SHAPIRO: Should we be worried about that?

ZUCKERMAN: Should we be worried? There is reason for concern just by looking at history. In 2007, you had a several-month period where these type of investors all struggled, and it did have an overall impact. People make the argument that it wouldn't happen again. They use many more signals and factors and data than ever before, and their risk management is much better. But some of us on the outside still have skepticism.

SHAPIRO: That's Gregory Zuckerman of The Wall Street Journal who worked on the series "The Quants." Thanks for joining us.

ZUCKERMAN: Great to be here. Transcript provided by NPR, Copyright NPR.