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.

1 comment:

  1. I couldn't agree more - giving students real world projects is the best way to help them learn.

    On our site (www.universityfinancelab.com) we have been surveying rooms as to the tools used and the resources and one really surprising stat is that only 31% of the labs have a simulation program.

    I think the trend moving into the next few years will be for schools to better integrate simulation tools to better leverage the trading labs.