High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems

354 Pages·2009·4.717 MB·English

by  Irene Aldridge

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High-Frequency
Trading
A Practical Guide to Algorithmic
Strategies and Trading Systems
IRENE ALDRIDGE
JohnWiley&Sons,Inc.
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Copyright(cid:1)C 2010byIreneAldridge.Allrightsreserved.
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LibraryofCongressCataloging-in-PublicationData:
Aldridge,Irene,1975–
High-frequencytrading:apracticalguidetoalgorithmicstrategiesandtrading
system/IreneAldridge.
p.cm.–(Wileytradingseries)
Includesbibliographicalreferencesandindex.
ISBN978-0-470-56376-2(cloth)
1.Investmentanalysis. 2.Portfoliomanagement. 3.Securities. 4.Electronic
tradingofsecurities. I.Title.
HG4529.A432010
332.64–dc22 2009029276
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
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To my family
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Contents
Acknowledgments xi
CHAPTER 1 Introduction 1
CHAPTER 2 Evolution of High-Frequency Trading 7
FinancialMarketsandTechnologicalInnovation 7
EvolutionofTradingMethodology 13
CHAPTER 3 Overview of the Business
of High-Frequency Trading 21
ComparisonwithTraditionalApproachestoTrading 22
MarketParticipants 24
OperatingModel 26
Economics 32
CapitalizingaHigh-FrequencyTradingBusiness 34
Conclusion 35
CHAPTER 4 Financial Markets Suitable
for High-Frequency Trading 37
FinancialMarketsandTheirSuitability
forHigh-FrequencyTrading 38
Conclusion 47
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vi CONTENTS
CHAPTER 5 Evaluating Performance
of High-Frequency Strategies 49
BasicReturnCharacteristics 49
ComparativeRatios 51
PerformanceAttribution 57
OtherConsiderationsinStrategyEvaluation 58
Conclusion 60
CHAPTER 6 Orders, Traders, and Their
Applicability to High-Frequency
Trading 61
OrderTypes 61
OrderDistributions 70
Conclusion 73
CHAPTER 7 Market Inefficiency and Profit
Opportunities at
Different Frequencies 75
PredictabilityofPriceMovesatHighFrequencies 78
Conclusion 89
CHAPTER 8 Searching for High-Frequency
Trading Opportunities 91
StatisticalPropertiesofReturns 91
LinearEconometricModels 97
VolatilityModeling 102
NonlinearModels 108
Conclusion 114
CHAPTER 9 Working with Tick Data 115
PropertiesofTickData 116
QuantityandQualityofTickData 117
Bid-AskSpreads 118
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Contents vii
Bid-AskBounce 120
ModelingArrivalsofTickData 121
ApplyingTraditionalEconometricTechniques
toTickData 123
Conclusion 125
CHAPTER 10 Trading on Market Microstructure:
Inventory Models 127
OverviewofInventoryTradingStrategies 129
Orders,Traders,andLiquidity 130
ProfitableMarketMaking 134
DirectionalLiquidityProvision 139
Conclusion 143
CHAPTER 11 Trading on Market Microstructure:
Information Models 145
MeasuresofAsymmetricInformation 146
Information-BasedTradingModels 149
Conclusion 164
CHAPTER 12 Event Arbitrage 165
DevelopingEventArbitrageTradingStrategies 165
WhatConstitutesanEvent? 167
ForecastingMethodologies 168
TradableNews 173
ApplicationofEventArbitrage 175
Conclusion 184
CHAPTER 13 Statistical Arbitrage
in High-Frequency Settings 185
MathematicalFoundations 186
PracticalApplicationsofStatisticalArbitrage 188
Conclusion 199
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viii CONTENTS
CHAPTER 14 Creating and Managing Portfolios
of High-Frequency Strategies 201
AnalyticalFoundationsofPortfolioOptimization 202
EffectivePortfolioManagementPractices 211
Conclusion 217
CHAPTER 15 Back-Testing Trading Models 219
EvaluatingPointForecasts 220
EvaluatingDirectionalForecasts 222
Conclusion 231
CHAPTER 16 Implementing High-Frequency
Trading Systems 233
ModelDevelopmentLifeCycle 234
SystemImplementation 236
TestingTradingSystems 246
Conclusion 249
CHAPTER 17 Risk Management 251
DeterminingRiskManagementGoals 252
MeasuringRisk 253
ManagingRisk 266
Conclusion 271
CHAPTER 18 Executing and Monitoring
High-Frequency Trading 273
ExecutingHigh-FrequencyTradingSystems 274
MonitoringHigh-FrequencyExecution 280
Conclusion 281