Tuesday, March 29, 2011

Ticker, ticker on the wall

I was asked the other day whether a scrolling ticker was necessary for an educational trading room.  It got me thinking about how technology has changed, particularly how easy it is to get information (data and interpretations) compared to when tickers were first invented.  The first stock ticker was created in 1867; there is a web site www.stocktickercompany.com that describes the history of tickers.  According to the site, the last stock ticker was made in 1960.  In recent years, electronic tickers have replaced the old ticker tapes.  There are many companies in the electronic ticker business, just do Google search for “digital stock ticker” and you will see a range of (fairly similar) offerings
No question about it, tickers are attractive.  The question posed was: how important are they, specially since they tend to be one of the most expensive components of an educational trading room.   My response at the time was vague, I think mainly because I am not sure there is a right answer.  On the one hand, tickers help make the statement “we have a trading room” and if I had the budget, I would want one too.  On the other hand, they can only display a small amount of data at a time, and the data is usually delayed by 15 to 20 minutes.  You can get real time quotes for stocks on your cell phone, so delayed quotes on a digital ticker don’t really transmit useful information in today’s world.  In fact, showing delayed quotes contradicts one of the main selling points of a trading room, which is to give students access to the “same technology and resources” as real world trading floors.  No real world trading floor that I have been to has delayed data on their tickers.  In fact, many don’t have tickers at all; traders have access to real time data on their desktops and other devices.  You can check for yourself: point your browser to Google images and type in "Trading Floor" in the search box.  You will see lots of rooms with information displayed on mounted devices but surprisingly few scrolling tickers.  The same exercise on Bing images gives similar results.
So what’s the right answer?  I think it ultimately is a resource question.  What matters is the effective integration of trading room resources into a curriculum.  A ticker cannot be integrated, it has no direct pedagogical value.  It serves to attract attention to the trading room.  So if you are investing sufficiently in teaching resources and can afford a ticker, definitely get one.  And don't forget that like any other technology, they will need to be maintained and upgraded. Otherwise, you would get a lot more use from systems that provide real content, like additional Bloomberg terminals or a Morningstar subscription.

Tuesday, March 15, 2011

Using Trading Simulations: Practice What You Teach

What is the role of trading simulations in a finance curriculum?  We think the real value added comes from helping students undertstand how concepts and techniques are translated and applied in practice, particularly the application of analytical techniques in markets. 

Of course, there are easy solutions.  You can tell your students: go trade whatever you want and write a report.  I am not against these, I think they give students a chance to observe what is going on in real world financial markets.   But they do not supply the experience or knowledge that is needed in todays world and the world your students will face: the impact of technology and analytics in shaping financial markets.

Our view is that you must understand how analytical tools are applied in practice, otherwise you will simply be a stock picker.  FTS accomplishes this by having a series of exercises (we call them projects) that are reinforce the practical application of the theory of investments.  Our goal is to use the simulations give students a deeper understanding of this theory in a real world, dynamic context and to enhance their analytical and model building skills.

For example, our virtual portfolio management system (we call it the FTS Real Time System) has about 25 specific projects for this purpose.  The projects bring to life the concepts being taught in class.  The payoff can be very large.  An essential part of the exercises is to conduct an analysis and interpret the results, whether it is understanding how to construct a diversified portfolio or using portfolio-wide option hedge parameters to manage risk.   To help students bridge the gap between theory and practice, our real time trading system comes with built in information and analytics, consistent with what is taught.  The algorithmic trading capability is particularly exciting: it allows the implementation of trading strategies that require frequent monitoring of markets, so in fact any dynamic trading strategy.  This is where markets are today; such trading strategies would be close to impossible to implement in "manual" trading simulations.

The approach is similar in the FTS Interactive Markets, our simulation with price discover.  These are exciting trading simulations where students trade with each other and experience what it is like to be on a trading floor.  What they trade is controlled by a trading case; you can see the list of standard cases at this link.  The modeling and analytical development comes from preparing for the cases, as shown in the student manual: modeling cash flows, valuing securities, developing hedging strategies, and even developing automated trading algorithms if you want.  These simulations give them the experience of a live trading floor, where orders are submitted, prices are negotiated, activity is fast paced and competitive, and everyone (or their algorithms) react in real time to the actions of others.

Thursday, March 3, 2011

The FTS Teaching Philosophy

I am often asked: what is the difference between FTS and other systems?  The essential difference is that we focus squarely on analytical and model building skills and their practical application.   We think that in today's world, with algorithms, data mining, high frequency trading, and so on, these skills are particularly important.  You can use other simulations, even some that let you trade many more securities, but without the analytics, they prepare you for the markets of 20 years ago, not today's or tomorrow's.

For example, consider a stock trading simulation where students manage a portfolio and trade at prices coming from real world exchanges.  The typical simulation out there lets you buy/sell any stock and you can see what happened to your portfolio.  This certainly provides a “practical” dimension.  But it does not go far enough in today's world.  In fact, in such systems, it is impossible to implement any strategy that requires either frequent monitoring of markets or rebalancing a large portfolio, and consequently, rules out any dynamic trading strategy or the use of analytics to guide investment and risk management decisions.  Any sophisticated investment strategy cannot be implemented.  Imagine the number of steps required to rebalance even a medium size equity portfolio, let alone any understanding of the cost of rebalancing.  Imagine hedging an equity portfolio with options without any analytical support. 
FTS provides that bridge.   We focus on bridging conceptual and analytical understanding to prepare students. for today's markets and the markets they will face  So we have a series of exercises and analytics built in to our virtual portfolio simulation (we call it the FTS Real Time System).  For example, students can learn how to apply mean variance efficiency and construct an efficient portfolio and learn about rebalancing in addition to reporting on what happened.  Our equity portfolio rebalancing analytics shows them the cash required to finance the trades and the transactions costs incurred, whether you trade 10 stocks or 1000.   They can even develop algorithmic trading strategies and see how they work (and at the same time build their modeling and Excel skills).  Besides reinforcing conceptual and practical knowledge, they also start to see how analytics and algorithms are such an integral, maybe even dominant, part of financial markets today.

The approach in the FTS Interactive Markets (markets with price discovery) is similar.  You can see the steps students follow in building their modeling and analytical skills in the student manual.  Here, the focus is on modeling cash flows, valuing securities, and, in a trading context, having a "plan B:" what to do if you cannot trade at the"theoretical" solution.  That's where students get a true understanding of how to effectively use their conceptual knowledge in a practical, experiential setting.  Going further, students can develop trading algorithms.  In fact, you can even have a trading  contest where student algorithms compete against each other.  This brings them closer to understanding financial markets today.  Perhaps even more importantly, they begin to appreciate how technology and analytics are shaping financial markets.

Note the difference between our two trading simulations: in the FTS Interactive Markets with price discovery, you trade with other students and all prices are endogenous.  So market impact is a key feature that is not a part of paper trading simulations.  We offer both because we believe it is just as important to experience real market dynamics, where everyone reacts to each other in real time, to paper trading simulations that are based on real world securities.  With FTS, you get both.

Another example is stock valuation: we like our students to perform a fundamental valuation from first principles, so they learn to be analysts as opposed to consumers of research reports. You can see an example of this approach in this Value Investing Project. This project also illustrates how students can dig deeper using the Financial Statement Analysis module. This module lets them learn how many of the aggregated reports (like those you would get from e.g. Morningstar or S&P) are created, including the assumptions these sources make. Again, they conduct an analysis from first principles, rather than simply reading calculated ratios and other quantities from a data source; reading other peoples analysis is a useful but easily replaceable skill.

To summarize, FTS focuses on three things: analysis, analysis, analysis, translated into analytics, and algorithms.  Students experience and begin to see how analytics and quantitative techniques are applied in portfolio management, and the role of quantitative trading, investment, portfolio and risk management, and high frequency trading in today's markets.  

Coming to the bottom line, there are three questions to ask
  • Do you want a trading simulation with price discovery as well as a virtual portfolio system and supporting analytical modules for one low price?  If the answer is yes, FTS is your only choice
  • Do you want students to learn how analytics and quantitative techniques are applied in portfolio management?  If the answer is yes, FTS is your only choice.
  •  Do you want students to understand how algorithms and high frequency trading have completely changed the nature of financial markets?  If so, FTS is your only choice.

Trading Rooms Don’t Have to be White Elephants

In 1993, Carnegie Mellon University opened the first educational trading room.  It had live feeds and developed a curriculum called the FAST Program that integrated the resources of the trading room into the curriculum.  We estimate there are approximately 200 educational trading rooms today.  Some are enormously successful, and early examples are in this article from BizEd magazine: http://www.aacsb.edu/publications/archives/jan03/p22-27.pdf

If you have a trading room or finance lab, the question you have to ask is: how does your trading room prepare your students to succeed in financial markets today and in the future?  Today's financial markets are a far cry from 1993.  High frequency trading, program trading, and analytics based trading dominates markets (just Google these terms and you will see the statistics and trends).  If you are using a simulation system, ask yourself: does it have the analytical support and the algorithmic capabilities that help students understand today's markets?  Or the markets as they were in 1993? 
A second question concerns benefits of a trading room/finance lab.  It is unfortunately true that most trading rooms, despite their flashy tickers and high costs, end up being be fancy computer labs with minimal impact on student education or benefiting very limited numbers of students.  Further, as online courses, distance learning courses, and evening and weekend classes expand, relying on access to a centralized facility with limited access becomes problematic.  Even more, while they may have state-of-the-art data resources (Morningstar, Capital IQ, Bloomberg), they don't always have state-of-the-art trading simulations and analytical tools. 

Here are some examples of what you can do with FTS:
  • You can create a live dealing room using the FTS Interactive Markets, where students trade with each other.  They experience what it is like to be in the middle of a live trading floor, where orders are submitted, prices are negotiated, activity is fast paced and competitive, and everyone reacts in real time to the actions of others.  They can learn to build simple (and complex!) support systems in Excel, and even learn how to build algorithmic trading strategies.  
  • You can run a virtual portfolio simulation (the FTS Real Time System), where students manage a portfolio, and trades take place at prices that come from real world exchanges.   Unlike the interactive markets, here there is no market impact (the real world prices don't react to the student activity).   Unlike others, our system has projects and built in analytics so students can learn how they are applied.  One example is our option hedging project: you have to use index options to hedge the risk of an equity portfolio.  You can't use individual stock options (you shouldn't really hedge each stock separately anyway!).  Our system provides portfolio level analytics that make this exercise feasible.  It would be very cumbersome otherwise.   Beyond that, the algorithmic trading capability lets students develop dynamic trading strategies that are impossible in "manual" trading simulations. 
  • Our modules provide ways for students to dig deeper.  The financial statement analysis module lets them understand how to study a company, and compare companies, from first principles.  They can do this at different levels: from the raw company filings or the simpler task of using aggregated statements provided by data vendors such as Morningstar and Compustat (to which many labs have a subscription).  The efficient portfolio module lets them explore statistical properties of portfolio returns as well as learn how mean-variance efficient portfolios are constructed.  Other modules deal with interest rate risk, options, and futures. 

Three questions to ask
o   Do you want a trading simulation with price discovery as well as a virtual portfolio system and supporting analytical modules for one low price?  If the answer is yes, FTS is your only choice.
o   Do you want students to learn how analytics and quantitative techniques are applied in portfolio management?  If the answer is yes, FTS is your only choice.
o   Do you want students to understand how algorithms and high frequency trading have completely changed the nature of financial markets?  If so, FTS is your only choice.