Algorithmic Trading Based on Directional Changes (Dissertation Sample)

Algorithmic Trading Based on Directional Changes
Li QIAN
Thesis, MSc in Computational Finance
University of Essex
2015
Abstract:
This paper surveys effects of market price fluctuations on traders’ decisions to buy or sell products and assets. The investigation is based on the data set of all the daily transactions at various prices. We obtain a positive contemporary correlation between the product prices and the choice of buying and selling in the market for earning returns. This correlation is stronger for buy decisions than sell decisions. This study uses two types of traders, the trend follower and the contrarian traders. For the trend followers, we obtain a negative correlation between the numbers and the volumes of buying and selling decisions along with the market returns. There are no significant negative correlations between the buying and selling decisions of the same size.
In addition this study investigates also whether the traders in this sample tend in this sense are motivated to sell or buy the very stock at a go. We will realize that between the trend follower and contrarians, this tendency is more pronounced for the trend followers than the contrarians are. We thus use the approach of simple moving averages for the automation of the buying and selling points at the down trend and uptrend points respectively.
Keywords: financial market, financial engineering, directional change, fitting function, overshoot values, financial environment, structure characteristics, financial technology
Table of Contents
1 Introduction
1.1 The concept of financial market
1.2 The economic function of financial market
1.3 The element of economic market
1.4 The classification of financial market
2 The background
2.1 The development of financial engineering
2.2 Literature Review
2.3 Theory and Component of financial engineering
2.4 Five Aspects of financial engineering
2.5 The Essence of Financial Engineering
2.6 The Innovation of Financial Derivatives
3 The introduction of the stock
3.1 The stock investment strategy
3.2 The stock analysis in the financial market
3.3 The all points of the financial market
3.4 The Environment of the Financial Market
4. Directional Changes based trading algorithm
4.1. Introduction of DC
4.2. Introduction of two algorithmic traders using DC
Trend Follower (TF) Algorithm and Contrarian Traders (CT) Algorithm
5 Experimentation
5.1. Objectives of the experiments [The objective is to test the trading algorithms.]
5.2. Data used
5.3. Experimentation set up [which program have you run on which set of data? Put the codes in the appendix. Show in this section how to run the program.]
5.4. Output of the program [show the output of the program, but if your program produces a lots of output, put them in an appendix.]
6. Summary of the Results
7. Conclusion
1 Introduction
This study gives the analysis of the variations in stock prices and the related factors, and their effects on decision making. It applies two algorithms of directional change determination, the trend follower’s algorithm and the contrarian algorithm. Distinguishing the direction of the asset prices in separate upward and downward movements shows different behaviors for the trend follower and the contrarian decisions in the markets (Richard & Barry 2009, p. 46). The outcomes from the short-term upward and downward price runs take longer period time compared to the contrary movements. It applies the methodology of Time series analysis, which is the assessment of the price variations from the price at the start of the period to the daily closing price (Xiong, Yukun & Zhongyi, 2013). The upward and downward movement in the prices is the directional change.This design is derived from the link between the trend-exploiting and the trend-strengthening practical trading. On the other hand, it stems from the prevalence of the expectation bias. This link of procedural and essential trading and the increased rate of transactions strengthened both the upward shifts of asset prices and their subsequent decline thereafter (Lawrance 1991, p. 28). Objective of this paper is that we study the algorithmic trading, including trend follower and contrarian trader, using the concept of directional change.
1.1 The concept of financial market
Simply speaking, finance refers to the financial and capital loan. In the uncertain environment and through financial markets, we could optimally allocate the financial resources. In addition, the financial market refers to the total supply and demand and in that market we could purchase or sell financial assets. That includes three meanings. First, it reflects a tangible or an intangible places for all financial assets. Secondly, it reflects a tangible or an intangible places for the supplier and demander of financial assets. Finally, it contains the operation mechanism of trading financial assets; one of the most important is the price mechanism. Any investment in the financial market, these investors uses a future and higher return to replace the current consumption. Investors face the financial risk in financial market including the market risk, the credit risk, the liquidity risk, the operational risk and the legal risk.
1.2 The economic function of financial market
Micro economic functions of financial market are in the price discovery, providing the liquidity and reducing transaction costs. Price discovery mechanism defines that participators in financial market are according to the requirements of issuers and investors to design various financial tools. Then, the financial institutions sell financial instruments to different types of investors. Liquidity defines buyers and sellers in financial markets are able to buy or sell financial assets and that is able to reduce the financial cost, which is useful to transact financial assets, Liquidity is able to promote the effective of the financial market as well. Macro economic functions reflect the macro economics of financial market. That financial market has many characteristics as follow. The financial market is able to allocate various resources. On macro economy, the regulatory effect of the financial market is that financial market can reflect the development of the economic situation, which is the core of the modern economy.
1.3 The element of economic market
The main body of the financial market is the participants of financial market. The main body of financial market into the financial market is in order to the monetary finance, which could be achieved by financial tools. Financial tools could not only achieve to allocation funds and resources again, but also help to transfer the financial risk. The characteristics of financial instruments have the liquidity and the risk. The financial market is including money market, capital market, foreign exchange market and future market. Money market refers to trade financial assets which are in one year in the trading market. Capital market refers to the asset of financial trading in more than one year in the financial market. Foreign exchange market is the trading place that is to transfer the foreign exchange or the different currency, which is an important part of financial market.
1.4 The classification of financial market
According to the characteristics of financial market, the primary market is the trading market where sellers who need funds to first sell the financial asset to the public. The other market is based on the primary market to develop. According to the pricing way, there are the open market and the bargaining market. The open market refers to the trading price of the financial asset, which is the public bidding of buyers and sellers. The other market refers to the pricing and trading of financial assets between buyers and sellers.
2 The background
2.1 The development of financial engineering 
The development of financial engineering emerged in last 80's, but the idea can be traced back to two thousand years ago. In the ancient Greece, one philosopher buy oil in advance, then the philosopher obtained higher profit. Then, the research show that method is defined to the call options. Later, people put that mind in keeping the price of agricultural products, industrial products and other commodities. Moreover, in 1848, the Chicago commodity exchange was established, which opened a new stage of futures trading. However, until the end of the twentieth century, with the financial liberalization and financial innovation, financial engineering becomes an independent subject.
In 1991, the “International Association of Financial Engineers” (IAFE) was established, and then, American professors Marshall and Bansal published a book, the book is about financial engineering, that book marks that financial engineering becomes an independent subject. With the development of financial engineering, the understanding of the financial engineering becomes more and more deepening and improvement. An American professor Finnerty defined financial engineering in 1988, financial engineering includes new financial tools and methods of the development and implementation as well as provide solutions on financial problems".
Marshall and Bansal have respected this definition; they think that definition has three implications. One is the high creativity, such as created the first zero coupon bonds and the first swap contracts. Two is develop original defines, such as futures extended to other field, previous, those field are not related, as a range of options and swaps. Three is that people could combine financial products and tools again. All of them are in order to adapt to the specific situations, such as long term swaps, futures options, exchange options and others.
In 1994, the British financial expert Galitz give...