advanced-algorithmic-trading

Chapter 1
Introduction To Advanced
Algorithmic Trading
1.1 The Hunt for Alpha
The goal of the quantitative trading researcher is to seek out what is termed alpha–new streams
of uncorrelated risk-adjusted returns–and then exploit these returns via a systematic trading
model and execution infrastructure.
Alpha is difficult to find, as by definition once it is well-known it decays and seeks to be
an uncorrelated source of returns. Instead it gradually becomes a risk factor and thus loses its
risk-adjusted profitability.
This book concentrates on three major areas of mathematical modelling–Bayesian Statistics,
Time Series Analysis and Machine Learning–that will augment your quantitative trading research
process in order to help you discover sources of alpha.
Many of these techniques are in use at some of the largest global asset managers and quantitative
hedge funds. In the following chapters these techniques will be described and applied to
financial data in order to develop testable systematic trading strategies.
1.2 Why Time Series Analysis, Bayesian Statistics and Machine
Learning?
In the last few years there has been a significant increase in the availability of software for
carrying out statistical analysis at large scales–the so called "big data" era.
Much of this software is completely free, open source, extremely well-tested and straightforward
to use. The prevalence of free software coupled to the availability of financial data, as
provided by services such as Yahoo Finance, Google Finance, Quandl and DTN IQ Feed, has
lead to a sharp increase in individuals deciding to become quant traders.
Unfortunately many of these individuals never get past learning basic "technical analysis".
They avoid important topics such as risk management, portfolio construction and algorithmic
execution–topics given significant attention in institutional environments. In addition "retail"
traders often neglect more effective means of generating alpha, such as can be provided via
detailed statistical analysis.
3