Jump to content

Welcome to the new Traders Laboratory! Please bear with us as we finish the migration over the next few days. If you find any issues, want to leave feedback, get in touch with us, or offer suggestions please post to the Support forum here.

  • Welcome Guests

    Welcome. You are currently viewing the forum as a guest which does not give you access to all the great features at Traders Laboratory such as interacting with members, access to all forums, downloading attachments, and eligibility to win free giveaways. Registration is fast, simple and absolutely free. Create a FREE Traders Laboratory account here.

UrmaBlume

A New Paradigm in Money Management

Recommended Posts

The need for speed

November 3rd 2008

 

Irene Aldridge, quantitative portfolio manager and managing partner at Able Alpha Trading in New York, looks at what defines a good high-frequency system

 

One out of every two money management job vacancies listed in October 2008 on the finance recruiting site eFinancialCareers.com was a search mandate for "high-frequency trading" professionals. A rush for a specific job category in the middle of the worst crisis since the Great Depression is unusual, particularly when most companies are enacting hiring freezes.

 

The reason for the hiring spree in the high-frequency field is simple: high-frequency trading is capable of generating money in all market conditions, whether a crisis or business as usual.

 

High-frequency trading is a new discipline among buy-side money managers. The main innovation is more frequent turnover of capital in response to changing market conditions. High-frequency environments are characterised by lower average gain per trade and a higher number of trades. While traditional money managers hold their trading positions for weeks or months at a time, high-frequency money managers typically execute multiple trades each day with few, if any, positions carried overnight. The absence of overnight positions is important for two reasons: 1) the continuing globalisation of capital markets extends most of the trading activity to 24-hour cycles, and with the current volatility, overnight positions are particularly risky; and 2) overnight positions taken out on margin have to be paid for at the interest rate referred to as an 'overnight carry rate', which is usually slightly above Libor. But with volatility in Libor and hyperinflation around the corner, overnight positions become increasingly expensive, and so unprofitable for many money managers.

 

While high-frequency trading enables the same strategy to be used across a wide range of financial securities, developing these trading strategies presents new challenges for money managers. The first fundamental challenge of high-frequency trading is the large volumes of intraday data. Most prudent money managers require at least two years of back-testing of the trading system to consider putting money behind it. Credible systems usually require four or more years of data to fully examine potential pitfalls, and dealing with this volume of numbers can be overbearing for most.

 

Another issue is that signals must be precise enough to work in fast-moving markets, where gains could quickly turn to losses if the signals are misaligned.

 

Speed of execution is critical to high-frequency trading. Traditional phone-in orders are not sustainable within the high-frequency framework. The only reliable way to achieve the required speed and precision is computer automation of order generation and execution. Programming high-frequency computer systems requires advanced skills in software development. Run-time mistakes can be costly and human supervision of trading in production remains essential to ensure the system is running within pre-specified risk boundaries. Discretion embedded in human supervision, however, should be limited to one decision only: whether or not the system is performing within pre-specified bounds and, if it is not, whether it is the right time to pull the plug.

 

What defines a good high-frequency system? As with any money management activity, the first metric to consider is the Sharpe ratio. For trading systems with no overnight positions, the Sharpe ratio equals the mean of returns divided by the standard deviation of returns. An annualised Sharpe ratio of 4, after all transaction costs, is becoming a de-facto benchmark for a solid, stable system in the industry. A system with a lower Sharpe might be profitable for short periods of time, but is statistically subject to blow-ups.

 

An annualised Sharpe ratio of 4 corresponds to a daily Sharpe ratio of 0.25. That is, daily standard deviation can be at most four times the average daily return. So, if the system or manager you are considering employing produces 0.1% per day on average, the maximum daily standard deviation of the returns should ideally fall under 0.4%. What this means in turn is that 68% of all daily returns should fall within one standard deviation from the mean, and 95% of all daily returns should fall within two standard deviations from the mean. In our example, 68% of all daily returns should fall within the -0.3% to 0.5% range, and 95% of all daily returns should fall between -0.7% and 0.9%.

 

The second consideration is sensitivity to latency. Many fast-moving markets are sensitive to timely execution. So a thorough understanding of what costs are involved when execution is delayed is a critical factor in understanding viability of a high-frequency trading system.

 

Other traditional metrics apply as well. A prospective investor in a high-frequency system should ask the system's manager questions about the maximum drawdown (a maximum peak-to-trough loss), betas (sensitivity to Standard & Poor's 500 and other macroeconomic indicators), value at risk (the loss potential at 95% probability level) and Sortino ratio (return over T-bills divided by average underperformance) among others. The manager's answers will not only indicate the stability of the system, but also reveal the manager's knowledge of, and attitude towards, risk management practices.

 

Overall, high-frequency trading is a difficult but profitable endeavour that can generate stable profits in various market conditions. Solid footing in both theory and practice of finance and computer science are the normal pre-requisites for successful implementation of high-frequency environments. And while past performance is never a guarantee of future returns, solid investment management metrics delivered on auditable returns net of transaction costs are likely to give investors a good indication of the high-frequency manager's abilities

Share this post


Link to post
Share on other sites

This article is really about a concept written about in the 1990's about how to increase the reward-risk relationship.

 

There are 2 ways to make your trading better. Find strategies that increase your ‘edge’ (the mean 'expectancy' of a trading method over the longer-term)--- difficult to do as trading is a very competitive game and there will always be a cap on how high you can get your % win rate.

 

Second, and this is where the world is going -- find strategies that have solid edge but you can repeat them more (high frequency trading). The sharpe ratio increases with either of these 2 ways.

 

I wrote about this here:

 

http://www.traderslaboratory.com/forums/f3/the-structure-of-trading-strategies-3603.html

 

The example I use is how to 'think' about strategies and taking the popular game of roulette as a useful example.

 

I learned this while reading a book called: "Active Portfolio Management" by Grinold & Kahn. This book is considered a bible by many money managers --- it is total overkill so I don't recommend the book unless you are a math major headed for quantitative finance. But the points made in it apply to all strategies, including short-term trading. If you compare two methods of trading, the one with lower edge might be a much more efficient strategy if it is high-frequency --- this is because the # of trades increases the statistical significance of the results and just like the house edge in roulette -- as the house, you would much rather do many spins at $25k each than just one roll at $1 million. In fact, you wouldn't even bother with the risk of $1 million, despite knowing you have an 'edge' in the game.

Share this post


Link to post
Share on other sites

Hmmm intresting article but is it really new and innovative? Amongst "buy side money managers" perhaps. Guess its all new to Irene Aldridge.

 

An article I would have expected to read in the late eighties or early nineties (similar economic climate then too):)

Share this post


Link to post
Share on other sites

The Sharpe ratio that is mentioned in this article has one big flaw that many people do not consider: It penalizes big profits. So if you make 10% profit in a day where 1% is standard, the standard deviation will be huge and therefore the Sharpe ratio rather low. There are much better measures for consistency, but I don't want to get into that...

Share this post


Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.
Note: Your post will require moderator approval before it will be visible.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.


  • Topics

  • Posts

    • Date: 29th March 2024. GBPUSD Analysis: The Pound Trades Higher But For How Long? The global Stocks Markets are closed due to Easter Friday (Good Friday). The NASDAQ continued to follow the sideways trend while other indices again rose. The SNP500 reaches an all-time high, but the NASDAQ remains under pressure from Tesla, Meta and Apple. The Euro continues to trade lower against all major currencies including the US Dollar, Euro and Japanese Yen. The British Pound is the best performing currency during this morning’s Asian session. However, investors are largely fixing their attention on this afternoon’s Core PCE Price Index. GBPUSD – The Pound Trades Higher but For How Long? The GBPUSD is slightly higher than the day’s open and is primary due to the Pound’s strong performance. At the moment, the British Pound is increasing in value against all major currencies. However, the US Dollar Index is also trading 0.10% higher and for this reason there is a slight conflict here. If investors wish to avoid this conflict, the EURUSD is a better option. This is because, the Euro depreciating against the whole currency market avoiding the “tug-of-war” scenario. The GBPUSD is trading slightly lower than the 2-month’s average price and is trading at 49.10 on the RSI. For this reason, the price of the exchange is at a “neutral” level and is signalling neither a buy nor a sell. The day’s price action and future signals are possibly likely to be triggered by this afternoon’s Core PCE Price Index. Analysts expect the Core PCE Price Index to read 0.3% which is slightly lower than the previous month but will result in the annual figure remaining at 2.85%. The PCE rate is different to the inflation rate and the Fed aims for a rate between 1.5% to 2.00%. Therefore, even if the annual rate remains at 2.85%, as analysts expect, it would be too high for the Fed. If the rate increases, even if only slightly, the US Dollar can again renew bullish momentum and the stock market can come under pressure. This includes the SNP500. Investors are focused on the publication of data on the UK’s gross domestic product (GDP) for the last quarter of 2023: the quarterly figures decreased by 0.3%, and 0.2% over the past 12-months. This confirms the state of a shallow recession and the need for stimulation. The data, combined with a cooling labor market and a steady decline in inflation, increase the likelihood that the Bank of England will soon begin interest rate cuts. In the latest meeting the Bank of England representatives did not see any members vote for a hike. USA500 – The SNP500 Rises to New Highs, But Cannot Hold Onto Gains! The price of the SNP500 rises to an all-time high, before correcting 0.33% and ending the day slightly lower than the open price. Nonetheless, the index performs better than the NASDAQ which came under pressure from Tesla, Meta and Apple which hold a higher weight compared to the SNP500. For the SNP500, these 3 stocks hold a weight of 9.25%, whereas the 3 stocks make up 14.63% of the NASDAQ. The SNP500 is also supported by ExxonMobil’s gains due to higher energy prices. The market will remain closed on Friday due to Easter. However, the market will reopen on Monday for the US and investors can expect high volatility. Investors will also need to take into consideration how the PCE Price Index and the changed value of the US Dollar is likely to affect the stock market next week. Always trade with strict risk management. Your capital is the single most important aspect of your trading business. Please note that times displayed based on local time zone and are from time of writing this report. Click HERE to access the full HFM Economic calendar. Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding on how markets work. Click HERE to register for FREE! Click HERE to READ more Market news. Michalis Efthymiou Market Analyst HFMarkets Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
    • MT4 is good and will be good until their parent company keep updating the software, later mt4 users will have to switch to mt5.
    • $SOUN SoundHound AI stock at 5.91 support area , see https://stockconsultant.com/?SOUN
    • $ELEV Elevation Oncology stock bull flag breakout watch , see https://stockconsultant.com/?ELEV
    • $AVDX AvidXchange stock narrow range breakout watch above 13.32 , see https://stockconsultant.com/?AVDX
×
×
  • Create New...

Important Information

By using this site, you agree to our Terms of Use.