Professional Automated Trading Theory and Practice

by Durenard, Eugene A.

• ISBN13: 9781118129852
• ISBN10: 1118129857
• Edition: 1st
• Format: Hardcover
• Copyright: 2013-10-21
• Publisher: Wiley

Summary

An insider's view of how to develop and operate an automated proprietary trading network

Reflecting author Eugene Durenard's extensive experience in this field, Professional Automated Trading offers valuable insights you won't find anywhere else. It reveals how a series of concepts and techniques coming from current research in artificial life and modern control theory can be applied to the design of effective trading systems that outperform the majority of published trading systems. It also skillfully provides you with essential information on the practical coding and implementation of a scalable systematic trading architecture.

Based on years of practical experience in building successful research and infrastructure processes for purpose of trading at several frequencies, this book is designed to be a comprehensive guide for understanding the theory of design and the practice of implementation of an automated systematic trading process at an institutional scale.

• Discusses several classical strategies and covers the design of efficient simulation engines for back and forward testing
• Provides insights on effectively implementing a series of distributed processes that should form the core of a robust and fault-tolerant automated systematic trading architecture
• Addresses trade execution optimization by studying market-pressure models and minimization of costs via applications of execution algorithms
• Introduces a series of novel concepts from artificial life and modern control theory that enhance robustness of the systematic decision making—focusing on various aspects of adaptation and dynamic optimal model choice

Engaging and informative, Proprietary Automated Trading covers the most important aspects of this endeavor and will put you in a better position to excel at it.

Author Biography

EUGENE A. DURENARD is CEO of DTC Ltd in Bermuda, a firm that specializes in applying systematic techniques to leveraged and real money trading across a wide variety of asset classes. DTC has been acting over the years as investment advisor and manager for a range of institutions including banks, hedge funds, and proprietary trading groups. DTC is currently advising Capital G, the largest private bank in Bermuda, where Eugene acts as Head of Research and Product Development. Eugene is a partner and CIO of ERA Capital Partners, a Chicago-based quantitative systematic Proprietary Trading Group.

Table of Contents

Preface xv

CHAPTER 1

Introduction to Systematic Trading 1

1.1 Definition of Systematic Trading 2

1.2 Philosophy of Trading 3

1.2.1 Lessons from the Market 3

1.2.2 Mechanism vs. Organism 5

1.2.3 The Edge of Complexity 5

1.2.4 Is Systematic Trading Reductionistic? 6

1.2.5 Reaction vs. Proaction 6

1.2.6 Arbitrage? 7

1.2.7 Two Viable Paths 7

1.3 The Business of Trading 7

1.3.1 Profitability and Track Record 8

1.3.2 The Product and Its Design 10

1.3.3 The Trading Factory 12

1.3.4 Marketing and Distribution 15

1.3.5 Capital, Costs, and Critical Mass 16

1.4 Psychology and Emotions 19

1.4.1 Ups and Downs 19

1.4.2 Peer Pressure and the Blame Game 20

1.4.3 Trust: Continuity of Quality 20

1.4.4 Learning from Each Other 21

1.5 From Candlesticks in Kyoto to FPGAs in Chicago 22

PART ONE

Strategy Design and Testing

CHAPTER 2

A New Socioeconomic Paradigm 33

2.1 Financial Theory vs. Market Reality 33

2.1.1 Adaptive Reactions vs. Rigid Anticipations 33

2.1.2 Accumulation vs. Divestment Games 37

2.1.3 Phase Transitions under Leverage 38

2.1.4 Derivatives: New Risks Do Not Project onto

Old Hedges 40

2.1.5 Socio-Political Dynamics and Feedbacks 41

2.2 The Market Is a Complex Adaptive System 42

2.2.1 Emergence 43

2.2.2 Intelligence Is Not Always Necessary 44

2.2.3 The Need to Adapt 45

2.3 Origins of Robotics and Artificial Life 45

CHAPTER 3

Analogies between Systematic Trading and Robotics 49

3.1 Models and Robots 49

3.2 The Trading Robot 50

3.3 Finite-State-Machine Representation of the

Control System 52

CHAPTER 4

Implementation of Strategies as Distributed Agents 57

4.1 Trading Agent 57

4.2 Events 60

4.3 Consuming Events 60

4.4 Updating Agents 61

4.5 Defining FSM Agents 63

4.6 Implementing a Strategy 66

CHAPTER 5

Inter-Agent Communications 73

5.1 Handling Communication Events 73

5.2 Emitting Messages and Running

Simulations 75

5.3 Implementation Example 76

CHAPTER 6

Data Representation Techniques 83

6.1 Data Relevance and Filtering of Information 83

6.2 Price and Order Book Updates 84

6.2.1 Elementary Price Events 85

6.2.2 Order Book Data 85

6.2.3 Tick Data: The Finest Grain 88

6.3 Sampling: Clock Time vs. Event Time 89

6.4 Compression 90

6.4.1 Slicing Time into Bars and Candles 90

6.4.2 Slicing Price into Boxes 96

6.4.3 Market Distributions 97

6.5 Representation 97

6.5.1 Charts and Technical Analysis 99

6.5.2 Translating Patterns into Symbols 101

6.5.3 Translating News into Numbers 102

6.5.4 Psychology of Data and Alerts 104

CHAPTER 7

Basic Trading Strategies 105

7.1 Trend-Following 105

7.1.1 Channel Breakout 106

7.1.2 Moving Averages 106

7.1.3 Swing Breakout 112

7.2 Acceleration 114

7.2.1 Trend Asymmetry 115

7.2.2 The Shadow Index 116

7.2.3 Trading Acceleration 117

7.3 Mean-Reversion 118

7.3.1 Swing Reversal 118

7.3.2 Range Projection 120

7.4 Intraday Patterns 122

7.4.1 Openings 122

7.4.2 Seasonality of Volatility 122

7.5 News-Driven Strategies 124

7.5.1 Expectations vs. Reality 124

7.5.2 Ontology-Driven Strategies 125

CHAPTER 8

Architecture for Market-Making 127

8.1 Traditional Market-Making: The Specialists 127

8.2 Conditional Market-Making: Open Outcry 128

8.3 Electronic Market-Making 129

8.4 Mixed Market-Making Model 131

8.5 An Architecture for a Market-Making Desk 134

CHAPTER 9

Combining Strategies into Portfolios 139

9.1 Aggregate Agents 139

9.2 Optimal Portfolios 141

9.3 Risk-Management of a Portfolio of Models 142

CHAPTER 10

Simulating Agent-Based Strategies 145

10.1 The Simulation Problem 146

10.2 Modeling the Order Management System 147

10.2.1 Orders and Algorithms 148

10.2.2 Simulating Slippage 149

10.2.3 Simulating Order Placement 151

10.2.4 Simulating Order Execution 153

10.2.5 A Model for the OMS 155

10.2.6 Operating the OMS 156

10.3 Running Simulations 158

10.3.1 Setting Up a Back Test 158

10.3.2 Setting Up a Forward Test 160

10.4 Analysis of Results 162

10.4.1 Continuous Statistics 163

10.4.2 Per-Trade Statistics 164

10.4.3 Parameter Search and Optimization 165

10.5 Degrees of Over-Fitting 167

PART TWO

Evolving Strategies

CHAPTER 11

Strategies for Adaptation 173

11.1 Avenues for Adaptations 173

11.2 The Cybernetics of Trading 175

CHAPTER 12

Feedback and Control 179

12.1 Looking at Markets through Models 179

12.1.1 Internal World 179

12.1.2 Strategies as Generalized Filters 180

12.1.3 Implicit Market Regimes 181

12.1.4 Persistence of Regimes 183

12.2 Fitness Feedback Control 184

12.2.1 Measures of Fitness 186

12.3 Robustness of Strategies 192

12.4 Efficiency of Control 193

12.4.1 Triggering Control 193

12.4.2 Measuring Efficiency of Control 194

12.4.3 Test Results 196

12.4.4 Optimizing Control Parameters 197

CHAPTER 13

Simple Swarm Systems 199

13.1 Switching Strategies 199

13.1.1 Switching between Regimes 200

13.1.2 Switching within the Same Regime 200

13.1.3 Mechanics of Switching and Transaction Costs 205

13.2 Strategy Neighborhoods 206

13.3 Choice of a Simple Individual from a Population 208

13.4 Additive Swarm System 210

13.4.1 Example of an Additive Swarm 211

13.5 Maximizing Swarm System 214

13.5.1 Example of a Maximizing Swarm 215

13.6 Global Performance Feedback Control 216

CHAPTER 14

Implementing Swarm Systems 219

14.1 Setting Up the Swarm Strategy Set 220

14.2 Running the Swarm 220

CHAPTER 15

Swarm Systems with Learning 223

15.1 Reinforcement Learning 224

15.2 Swarm Efficiency 224

15.3 Behavior Exploitation by the Swarm 225

15.4 Exploring New Behaviors 227

15.5 Lamark among the Machines 227

PART THREE

Optimizing Execution

CHAPTER 16

Analysis of Trading Costs 231

16.1 No Free Lunch 231

16.2 Slippage 232

16.3 Intraday Seasonality of Liquidity 233

16.4 Models of Market Impact 234

16.4.1 Reaction to Aggression 235

16.4.2 Limits to Openness 235

CHAPTER 17

Estimating Algorithmic Execution Tools 237

17.1 Basic Algorithmic Execution Tools 237

17.2 Estimation of Algorithmic Execution

Methodologies 240

17.2.1 A Simulation Engine for Algos 240

17.2.2 Using Execution Algo Results in Model

Estimation 241

17.2.3 Joint Testing of Models and Algos 242

PART FOUR

Practical Implementation

CHAPTER 18

Overview of a Scalable Architecture 247

18.1 ECNs and Translation 247

18.2 Aggregation and Disaggregation 249

18.3 Order Management 250

18.4 Controls 250

18.5 Decisions 251

18.6 Middle and Back Office 251

18.7 Recovery 252

CHAPTER 19

Principal Design Patterns 253

19.1 Language-Agnostic Domain Model 253

19.2 Solving Tasks in Adapted Languages 254

19.3 Communicating between Components 257

19.3.1 Messaging Bus 258

19.3.2 Remote Procedure Calls 259

19.4 Distributed Computing and Modularity 260

19.5 Parallel Processing 262

19.6 Garbage Collection and Memory Control 263

CHAPTER 20

Data Persistence 265

20.1 Business-Critical Data 265

20.2 Object Persistence and Cached Memory 267

20.3 Databases and Their Usage 269

CHAPTER 21

Fault Tolerance and Recovery Mechanisms 273

21.1 Situations of Stress 273

21.1.1 Communication Breakdown 273

21.1.2 External Systems Breakdown 274

21.1.3 Trades Busted at the ECN Level 275

21.1.4 Give-Up Errors Causing Credit Line Problems 276

21.1.5 Internal Systems Breakdown 277

21.1.6 Planned Maintenance and Upgrades 277

21.2 A Jam of Logs Is Better Than a Logjam of Errors 277

21.3 Virtual Machine and Network Monitoring 278

CHAPTER 22

Computational Efficiency 281

22.1 CPU Spikes 281

22.2 Recursive Computation of Model Signals

and Performance 282

22.3 Numeric Efficiency 285

CHAPTER 23

Connectivity to Electronic Commerce Networks 291

23.1 Adaptors 291

23.2 The Translation Layer 292

23.2.1 Orders: FIX 292

23.2.2 Specific ECNs 293

23.2.3 Price Sources: FAST 293

23.3 Dealing with Latency 294

23.3.1 External Constraints and Co-Location 294

23.3.2 Avoid Being Short the Latency Option 295

23.3.3 Synchronization under Constraints 296

23.3.4 Improving Internal Latency 297

CHAPTER 24

The Aggregation and Disaggregation Layer 299

24.1 Quotes Filtering and Book Aggregation 300

24.1.1 Filtering Quotes 300

24.1.2 Synthetic Order Book 301

24.2 Orders Aggregation and Fills Disaggregation 301

24.2.1 Aggregating Positions and Orders 301

24.2.2 Fills Disaggregation 303

24.2.3 Book Transfers and Middle Office 303

CHAPTER 25

The OMS Layer 305

25.1 Order Management as a Recursive Controller 305

25.1.1 Management of Positions 307

25.1.2 Management of Resting Orders 307

25.1.3 Algorithmic Orders 308

25.2 Control under Stress 309

25.3 Designing a Flexible OMS 310

CHAPTER 26

The Human Control Layer 311

26.1 Dashboard and Smart Scheduler 311

26.1.1 Parameter Control 311

26.1.2 Scheduled Flattening of Exposure 312

26.2 Manual Orders Aggregator 313

26.2.1 Representing a Trader by an Agent 313

26.2.2 Writing a Trading Screen 314

26.2.3 Monitoring Aggregated Streams 314

26.3 Position and P & L Monitor 314

26.3.1 Real-Time Exposure Monitor 315

26.3.2 Displaying Equity Curves 315

26.3.3 Online Trade Statistics and Fitnesses 315

26.3.4 Trades Visualization Module 317

CHAPTER 27

The Risk Management Layer 319

27.1 Risky Business 319

27.2 Automated Risk Management 320

27.3 Manual Risk Control and the Panic Button 320

CHAPTER 28

The Core Engine Layer 323

28.1 Architecture 323

28.2 Simulation and Recovery 325

CHAPTER 29

Some Practical Implementation Aspects 327

29.1 Architecture for Build and Patch Releases 327

29.1.1 Testing of Code before a Release 327

29.1.2 Versioning of Code and Builds 328

29.1.3 Persistence of State during Version Releases 328

29.2 Hardware Considerations 329

29.2.1 Bottleneck Analysis 329

29.2.2 The Edge of Technology 330

Appendix

Auxiliary LISP Functions 333

Bibliography 341

Index 351