Trading Strategies Introduction

Trading Loop

Trading Loop

Trading Loop

Trading Loop

Three Strategies

2. Momentum1. Mean Reversion 3. Pairs Trading

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Budish, E., Cramton, P., & Shim, J. (2015). The high-frequency trading arms race: Frequent batch auctions as a market design response.

Mean Reversion Strategy

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3. Sell when yt > (1+d)mt

Moving AverageStock Priceyt

mt

Algorithm Data

Algorithm Parametersw Moving window lengthd Price threshold (%)

1. Calculate moving average mt of stock price at a time t with the moving window length, w.

2. Buy when yt < (1 – d)mt

Simple Moving Average

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time (t) price (yt)

t - 4 $311.23

Simple Moving Average

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time (t) price (yt)

t - 4 $311.23

t - 3 $316.50

Simple Moving Average

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time (t) price (yt)

t - 4 $311.23

t - 3 $316.50

t - 2 $318.27

Simple Moving Average

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time (t) price (yt)

t - 4 $311.23

t - 3 $316.50

t - 2 $318.27

t - 1 $320.47

Simple Moving Average

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time (t) price (yt)

t - 4 $311.23

t - 3 $316.50

t - 2 $318.27

t - 1 $320.47

t $315.69

Simple Moving Average

Example: 5 day moving average

AAPL stock price the last 5 days

time (t) price (yt)

t - 4 $311.23

t - 3 $316.50

t - 2 $318.27

t - 1 $320.47

t $315.69

Pairs Trading

Idea:

Companies that make similar products should have very similar changes in stock price.

For example Coke and Pepsi.

Source (madison.com)

Pairs Trading

Pairs Trading Strategy:

When Pepsi drops more than Coke• Buy Pepsi stock and Sell Coke stock.

When Coke drops more than Pepsi• Buy Coke stock and Sell Pepsi stock.

Source (madison.com)

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Moving AverageDifferenced Stock Priceyt

mt

Algorithm Data Algorithm Parametersw Moving window lengthd Price threshold (%)

1. Calculate moving average mt of stock price at a time t with the moving window length, w.

2. Buy KO, Sell PEP when yt < (1 – d)mt

3. Sell KO, Buy PEP when yt > (1+d)mt

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Pairs Trading - MacroSimilar Opportunities exist across entire “sectors”

• Banks and Insurance

• Restaurants and Travel

https://elite.finviz.com/map.ashx?t=sec&st=w52 YTD performance across sectors

Momentum ModelIdea:

Follow the volatility/trend that a time series may exhibit.

Sometimes this volatility can occur as a result of a fundamental change in a business or it’s environment. Such changes could imply a stock dramatically mis-priced.

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Examples

Zoom Beyond MeatTradingview.com

Momentum Strategy

Rate of Change

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Number of periods to look back

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Algorithm DataStock Pricest

Algorithm Parametersn ROC lookback periods

1. Calculate rate of change roct of stock price at a time t with the lookback period, n.

Rate of Changeroct d ROC threshold

2. Buy when roct moves above threshold d.

Trading Algorithms in CloudEx