Chapter 120 - The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution
Launched the Quant Revolution” by Gregory Zuckerman.
Jim Simons was an American mathematician, hedge fund manager, and philanthropist, renowned for founding Renaissance Technologies and its Medallion Fund, which used quantitative analysis and algorithmic trading to achieve extraordinary returns. He was a pioneering figure in applying advanced mathematics to finance, earning the nickname "Quant King”.
Here’s what I have learned:
Quantative Decision-Making
“Errors using inadequate data are much less than those using no data at all.”
— Charles Babbage
Jim Simons, also known as the Quant King is well-known for taking a mathematical approach to investing and problem-solving. As a matter of fact, unlike most investors, Simons did not have a traditional finance background, but instead, he applied rigorous mathematical models to understand and predict market behavior. His background in theoretical mathematics became the secret weapon that enabled him to decode complex market patterns.
From a young age, Jim Simons was fascinated by numbers and abstract concepts. His early interest in mathematical paradoxes and theorems hinted at his future ability to become the father of quantitative investing. As Gregory Zuckerman wrote, “What Jimmy liked to do more than anything else was think, often about mathematics. He was preoccupied with numbers, shapes, and slopes. At the age of three, Jimmy doubled numbers and divided them in half, figuring out all the powers of 2 up to 1,024 before becoming bored.”
This early mathematical curiosity translated into a lifelong commitment to uncovering hidden structures and patterns. His mindset led him to develop models that did not try to explain why markets behaved a certain way but instead focused on identifying states and patterns that could be exploited for profit. Zuckerman explained that Simons “concluded that markets didn’t always react in explainable or rational ways to news or other events, making it difficult to rely on traditional research, savvy, and insight. Yet, financial prices did seem to feature at least some defined patterns, no matter how chaotic markets appeared, much as the apparent randomness of weather patterns can mask identifiable trends.”
In fact, Simons believed that with enough data, one could make reliable predictions about the market. He embraced computers and algorithms early on, using them to process vast amounts of market data and uncover subtle signals invisible to human investors. Jim Simons’ mantra quickly became “There’s no data like more data.”
“Simons and his colleagues ignored the basic information most investors focus on, such as earnings, dividends, and corporate news, what the code breakers termed the ‘fundamental economic statistics of the market.’ Instead, they proposed searching for a small number of ‘macroscopic variables’ capable of predicting the market’s short-term behavior. They posited that the market had as many as eight underlying ‘states’—such as ‘high variance,’ when stocks experienced larger-than-average moves, and ‘good,’ when shares generally rose.”
— Gregory Zuckerman
One big advantage of Jim Simons’ quantitative investing is the fact that by relying on data and algorithms, he removed any human biases and emotions from investing decisions. In fact, Gregory Zuckerman explained that Simons argued “that it wasn’t important to understand all the underlying levers of the market’s machine, but to find a mathematical system that matched them well enough to generate consistent profits.” As Simons once said, “I don’t know why planets orbit the sun. That doesn’t mean I can’t predict them.”
As we have previously learned from Warren Buffett and Benjamin Graham, the stock market is filled with investors that are irrational which leads to stocks often being traded above or below their intrinsic value. Graham coined the term “Mr. Market” to explain this concept. In his 1987 Berkshire Hathaway letter to share holders, Warren Buffett explained the concept of “Mr. Market” as the following:
“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions, he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”
Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?
The value of market esoterica to the consumer of investment advice is a different story. In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.
Following Ben’s teachings, Charlie and I let our marketable equities tell us by their operating results – not by their daily, or even yearly, price quotations – whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it. As Ben said: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” The speed at which a business’s success is recognized, furthermore, is not that important as long as the company’s intrinsic value is increasing at a satisfactory rate. In fact, delayed recognition can be an advantage: It may give us the chance to buy more of a good thing at a bargain price.”
— Warren Buffett
Finding “Killers”
“I found that when you get enough “A” players together, when you go through the incredible work to find these “A” players, they really like working with each other. Because most have never had the chance to do that before. And they don’t work with “B” and “C” players, so it’s self-policing. They only want to hire “A” players. So you build these pockets of “A” players and it just propagates.“
— Steve Jobs
One of the most striking aspects of Jim Simons’ success is his ability to surround himself with brilliant talents, particularly from fields outside of traditional finance. As we mentioned previously, Simons recognized that the key to solving the market lay not in Wall Street expertise but in the analytical prowess of mathematicians, scientists, physicists, and computer scientists. In fact, Simons developed a unique perspective on talent, he was looking for “killers”, those with a single-minded focus who wouldn’t quite on a math problem until arriving at a solution.
Luckily for him, there weren’t much job prospective for maths majors outside of academics, and as such, it was easy for Renaissance Technologies to hire top talents from the field of mathematics. This was even more enhanced during Simons’ tenure as a university administrator; he tailored his recruitment pitch to individual desires, offering raises to those motivated by money or lighter workloads to those focused on research. Zuckerman wrote, “As he raided other schools, Simons refined his pitch, focusing on what it might take to lure specific mathematicians. Those who valued money got raises; those focused on personal research got lighter class loads, extra leave, generous research support, and help evading irritating administrative requirements.”
The recruitment of figures like Elwyn Berlekamp and James Ax, both acclaimed mathematicians with no finance background, exemplifies this strategy. Their contributions, alongside later hires like René Carmona, who specialized in stochastic equations, were pivotal in developing sophisticated models.
“Work with the smartest people you can, hopefully smarter than you.”
— Jim Simons
Furthermore, Jim Simons understood that once he hired A players, it was important to let them work. As Buffett once said, "And so the important thing we do with managers, generally, is to find the .400 hitters and then not tell them how to swing." Similarly, at Renaissance Technologies, Simons established a culture of collaboration and openness. Zuckerman explained that “Simons created a culture of unusual openness. Staffers wandered into colleagues’ offices offering suggestions and initiating collaborations. When they ran into frustrations, the scientists tended to share their work and ask for help, rather than move on to new projects, ensuring that promising ideas weren’t ‘wasted,’ as Simons put it.”
For example, while managing the Medallion Fund, Jim Simons insisted on a single, transparent trading system where all staff had access to the source code so that everyone could contribute to the improvement of the trading system. This environment fostered idea-sharing and collective problem-solving, turning individual brilliance into a synergistic force.
“All staffers enjoyed full access to each line of the source code underpinning their moneymaking algorithms, all of it readable in cleartext on the firm’s internal network. There would be no corners of the code accessible only to top executives; anyone could make experimental modifications to improve the trading system.”
— Gregory Zuckerman
Finally, Simons understood that in order to retain these “killers”, it was important to provide sufficient compensation based on the success of the firm. As Zuckerman wrote, “Simons used compensation to get staffers focused on the firm’s overall success. Every six months, employees received a bonus, but only if Medallion surpassed a certain profit level. The firm paid some of the money over several years, helping to keep the talent around. It didn’t matter if staffers uncovered new signals, cleaned data, or did other lower-profile tasks; if they distinguished themselves, and Medallion thrived, they were rewarded with bonus points, each of which represented a percentage of Renaissance’s profit pool and was based on clear, understood formulas.”
This reminds me of the story of Les Schwab. His success in business was built on the belief of profit sharing as a mean to empower employees. In fact, Schwab firmly believed right from the beginning that when employees are treated as partners, they become more invested in their work. As such, Les Schwab first started by sharing 50 percent of the profits of each new store with its manager, and later on, they changed their profit sharing structure to share over 49.51% of their profits with employees working in the stores. The logic is simple; when workers see a direct link between their efforts and the company’s success, they are more likely to go above and beyond in their roles.
Les Schwab once said, "I never could understand why more business people don't share with their employees. What nicer thing can they do with their profits? You can't take it with you. Naturally you should look out for your family, but you can always come out better for your family if you look out for your employees first."
This approach not only fosters loyalty but it also creates a culture of accountability and motivation. By sharing profits with his employees Schwab cultivates an environment where employees feel valued and recognized for their contributions. This sense of ownership translates into higher productivity and morale, which ultimately benefits the entire organization. As he once said, “I encourage you to share profits with your employees. I encourage you in every way possible to ‘Build People.’ This is good for America, it is good for you, and it is good for your employees.”
“If you make people under you successful, what happens to you? Aren't you also then successful?”
— Les Schwab
Beyond the Book
Read “ A Primer on Algorithms and Bias” by Farnam Street
Read “ The Timeless Parable of Mr. Market” by Farnam Street
Read “ The Importance of Working With “A” Players” by Farnam Street
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