Hack the market

Honda made a clever marketing campaign based on the old motorcycling insight that “Stupid hurts.” Like many keen observations, it’s applicable in many domains including trading and algorithm development. As a seasoned practitioner recently quipped to me: “The opposite of artificial intelligence is genuine stupidity.” If you’re trying to write smart systems, it may be worthwhile to spend some time reflecting on stupid.

I’ve recently had the opportunity to work with a brilliant mathematician. One of the first techniques he wanted to apply to our strategy development process is the mathematician’s old trick of inversion - instead of being clever and looking for smart algorithms, let’s see if we can happen across a dumb algorithm and invert it! This is a sound idea, but experience with algorithmic trading yields the unhappy result:

The opposite of stupid is not (necessarily) smart.

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performance analysis, strategy development

It turns out that one can actually sculpt or engineer randomness. Further, this ability can shed remarkable light on otherwise mysterious phenomena - like the value of an option or the performance of a complex trading strategy. The applet above is governed by the equation (for Geometric Brownian Motion) below. It provides you with the ability to produce a random stream with three modifiable characteristics: an initial value (in this case fixed at 100), volatility (or ‘diffusion’) and expected return (or ‘drift’ or slope). Every five seconds it will generate a new path based on the current settings. Hopefully, this applet provides a little insight into the machinery of a powerful algorithmic trading tool: monte-carlo methods. Read more…

EMS Internals, monte-carlo methods, open-source software, performance analysis