(CO MaMiom tet AN INTRODUCTION TO ALGORITHMIC TRADING BASIC TO ADVANCED STRATEGIES Edward Leshik and Jane Cralle AW we iz ANN NA \ KS \ : WAS \(CO MaMiom tet AN INTRODUCTION TO ALGORITHMIC TRADING BASIC TO ADVANCED STRATEGIES Edward Leshik and Jane Cralle AW we iz ANN NA \ KS \ : WAS \PRPCGSMEL — QC:FCGSPH TSP fn SWBK406Leshik Febery 2.2011 1016 Printer Name: Yer Come ‘Thisescon Ht polished 2011 Copyeight © 2011 etn Wiley & Sons Lad Registered ofce Jab Wile & Sons Lid The Asim, Southern Gale, Chics, West Sussex POLS 8SQ. ‘Unies Kingdom | For deals of oor global oil fics for ustomer services for ifoematon about how to ane for permission wo ease he copy ight materia ths book please see our website t wwe. com The right ofthe suthor to be ete asthe ath ofthis Weck hss hoon asete a secon ith the Copyeigt, Desges tnd Patents Act 108K, Altihec reserve. par ofthis publication may berepresuce, sored ina retrieval syste oF rani, nay Forma by aey means, lectonic, mechanical phetoeaprine ecard oatherwive, ‘xcapt as pormitoshy the UK Copyright, Designs and Patents Act 1988, without th rer pansion of the pulser. ‘ile so publishes is oka vary of eleewonic Formats. Some cometh sppears in pint my ote availabe in letonic books, Designations used by companies distinguish their produce ae often claimed astrndemarks, All rand tres ad prot aries ed itis book trade nares serve mars, rademarks Feiss under of tee respective capers. The pulser is mit soci with ny prt vendor ‘ato ats ba Ti publ is tiie Uo evden dad ove ein ‘ecano the subjec mr covered lll on the wodestaning hat the pubes sna engaged in ering profesional services If profession vice or othr exPertwsnince a rays the services ‘fa competent profesional should be sph For other tls ia the Wiey Trading Seles reas sce wey. comfioance ‘A citaloguc cord fortis book is aalale fom the Bei Litrary ISBN 978.0-170-68051-7 dhadlueh); ISBN 078.0470.97936-8 (Bk) ISBN 975:1-119-92500-0 (eb: ISHN 978-1-119-97500-6 eh) “Typse in 10/129 Times by Aptara He. New Debi Ena ited in Great Britain by TY Ineratonal Lid, Paco, CornsPRFCGSME —_QC-FCGSPE —TH:SPHT fm WKS coh Febery 2,2011 1916 Pinar Name: Yetta Come Contents Acknowledgments Mission Statement PART 1 INTRODUCTION TO TRADING ALGORITHMS, Preface to Part L L_ History 2__All About Trading Algorithms You Ever Wanted to Kaos, 3._Algos Detined and Explained 4 Who Uses and Provides Algos 5._Why Have They Become Mainsrear so Quickly? 6 Curenaly Popular Atgos 1_A Perspective View From a Tir | Company How w Use Algos for Individual Traders 9. How 1 Optimize Individual Trader Algos 10. The Future = Where Do We Go trom Here? fe W Io 2» 3 uPRFCGSPE —_QC-FCGSPE —TH:SPHT Fon JWHKGL shi —_Febeuny 2,201 E916 Pater Name: Yet to Come (2 Math Toolkit 43 Statisties Toolbox 14_Data ~ Symbol, Date, Timestamp, Volume, Price 61 AS Excel Mini Seminar 16__Bxcel Charis: How to Read Them and How to Build Them ___98 17_Qur Metrics — Algometrics 8 18 Stock Personality Clusters 8s 19 Selecting a Cohort of Trading Stocks 89 20 Stock Profiling 1 21_Siyistie Properties of Equity Markets 93 22_Vorutty 91 23._Reeurns ~ Theory 101 24 Benchmarks and Performance Measures 193 25 _Qur Trading Algorithms Described ~The ALPHA ALGO, Swalesies L_ALPHACL (DIFF) 107 la,_The ALPHA-I Algo Expressed in Excel Function Language 109 2._ALPHA-2 (EMA PLUS) VI And V2 Lo ALPHAc4 (High Frequency Real-Time Matrix) 2 5._ALPHA-S (Firedawn) uyol SWBKA9WLesbk —Januay' 17,2011 72). Primer Nae: Yetso Come 8 Ineaduction to Trading Algaritrns ‘The origin of what was to become the very frst algorithmic trade ean be roughly traced back to the world’s first hedge fund, set up by Alfred Winslow Jones in 1949, who used a strategy of balancing long and short positions simultaneously wish probably « 30:70 ratio of short to long. The first sliring of quant finance In equities trading there were enthusiasts from the advent of computer availability In the easly 1960s who used their computers (aften clandestinely *horsowing” some ‘computer time from the mainframe of their day job) to analyze price movement of stocks on a long-term basis, from weeks to months. Peter N, Hiaurlan, a rocket scientist in the 19608 atthe Jet Propulsion Laboratory, where he projected the trajectories of satellites, is said ta be one of the frst to use a computer to analyze stock data (Kirkpatrick snd Dahlquist, pp. 135). Combining his technical skills he began calculating exponential moving vera later published the “Trade Levels Reporis” ‘Computers came into mainstream use for block trading in the 1970s with the definition of a block tride being $1 million in value or more than 10 000 shares in the trade. Considerable controversy accompanied this advance. ‘The real stat of trae algorithmic trading as itis now perceived can be attributed to the invention of ‘pair trading, later also to be known as statistical arbitrage, or ‘statarb (mainly t make it sound more ‘coo!’), by Nuazio Tartaglia who brought together at Morgan Stanley circa 1980 a multidiseiplinary team of scientists headed bby Gerald Bamberger “Pair trading” soon became hugely profitable and almost Wall Street cult. The criginal team spawned many successful individuals who pioncered the intensive use of computing power to obtain a competitive edge over their colleagues. David Shaw, James Simons and a number of others* genealogy ean be raced back to those pion ‘at Morgan Stanley. ‘The ‘Black Box” was born, As computer power inereased almost miriculously sceording t Moore's Law (speed doubles every eighteen months, and still does today, well over a thind of a century after he fst promulgated the hold forecast) and computers Became main stream tools, the power of computerized algorithmic trading becanie irresistible. This advance was coupled with the invention of Direct Market Access for non Exchange _members enabling trates to be made by individual traders via their brokerages, Soon all major trading desks were running algos. ‘As Wall Sereet (hoth the Buy side mutual funds ete. with their multi-ittion dollar vaults and the aggressive Sell side brokerages) soon discovered that the hu Increase in computer power needed different staffing to deliver tke promised Holy Grail, they pointed their recruiting machines atthe top universities sueh as Stanford, Harvard and MIT. “The new recruits had the vague misfortune to be labelled “quants” no matter which iscipline they originated from — physics, statistics, mathematies This intellectual invasion ofthe financial spaee soon changed the cultural landscape of the trading floor. The ‘high personality” tader/brokers were slawly foreed to 8 less ‘dominant position. Technology became all-pervasive.om IWBKA96TLedik January 17,2011 7:25 Proter Nam: Yotto Come 2 All About Trading Algorithms You Ever Wanted to Know... (Q¢ Tn layman's language what are they really? A; Algorithms are lists of steps or insirustions which start with inputs and end witha desired output or resull Q: Do Thave to know much math? A: No, but it helps, We will provide what you need for ur algos in Part IT of this book. Q What about statistics ? A: High school level helps. Part IT of the book has a chapter which eavers most cof what you will need. Q: Do I need tw know Excel? A: The hook will guise you through all you need to know te use the algorithm templates whielt are on the CD and desevibed in detail in Par II. Bxee! isi mest convenient workhorse and de facto Q: Do [need to be generally computes A: Not that much really ~ basic computer literacy and ability wv handle fies and ‘mouse skill. For any real equipment function malfinetions call in an IT guy to ‘woubleshoot the problern Q Do Ihave to understand the detailed workings of the algorithins? Ac A qualified ‘no’. OF course understanding how the machine works is an asset ‘but yau can drive a car with knawing how the engine warks. Hf you want to design algos you will need to kniaw where the clutch is and what it does \gorithms wark bet also vary over time. oeks than an others? (continued)‘gppDJWDBKSDeHLeshik —Janunty 28.2011 16:52 Printer Name: Yet w Come 0 Appenclces oxy OXY 3rd QTR 2009 DATE oriioy | Matcap 05,697.64 Open 3482 Shares SUL 67 Close EPS. 208 MIN 1.45 PIE MAX. 5160 BETA, Range 18s INST SIRANGE, 0.023 you. 340 TXN SHARESITXN TRAVERSE SHARPE 1507 Company Description Occidental Petroleum Corporation (Oveidental) conducts its operations through vari- ‘ous ol and gas, cheriea, midstream, marketing and ether subsidiaries, and affiliates, The company operates in three business segments: the oll and gas segment, the chem- Jeal segment, and midstream, marketing and other segment. The oll and gas segment explores for, develops, produces and markets erude oil, natural gas Higuids (NGL), condensate snd natural gas, The chemical segment (OxyChets) mansfactares and ‘markets basie chemicals, vinyls and performance chemicals, The midstweam, market ing and other segment (midstream and marketing) gathers, teats, processes, trans: ports, stores, trades and markets crude ol, natural gas, NGL. condensate and carbon dioxide (COs) and generates and markets power. In February 2008, Oceidental pur- chased from Plains a 50% interest in oil and gas properties in the Permian Basin and ‘western Colorado, ‘Our Comments ‘Careful but can give good results with ALPHA“ el