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Algorithm Switching: Co-Adaptation in the Market Ecology

Chris Stephens and Henri Waelbroeck
The Journal of Trading Summer 2009, 4 (3) 59-73; DOI: https://doi.org/10.3905/JOT.2009.4.3.059
Chris Stephens
is a director of research at Adaptive Technologies, Inc. in Phoenix, AZ, and research professor at the Centro de Ciencias de la Complejidad, UNAM in Mexico.
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  • For correspondence: christopher.stephens@adaptiveinc.com
Henri Waelbroeck
is a vice president and director of research at Pipeline Financial Group, Inc. in New York, NY.
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  • For correspondence: henri@pipelinefinancial.com
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Abstract

Algorithm design for trading has concentrated on representing particular trading strategies that are familiar to, or at least understandable by, traders. A fundamental characteristic of markets however, is their evolvability, with traders continually adapting their strategies to current market conditions. In this sense, a market can be fruitfully viewed as an “ecology” of trading strategies. If trading algorithms are to be truly “intelligent” they must capture this capability of human traders to adapt, and “switch” strategy, in response to changing market conditions.

In this article, we first discuss why it is important to be able to switch algorithms. We then outline a framework within which such switching can be understood. This entails having a taxonomy for different trading strategies, and an understanding of how the transferal of information due to order flow between the market and a given strategy impacts the performance of an algorithm, both in terms of participation rate and market impact. We discuss the predictability of this information transferal showing how this can be used to build an “algorithmic switching engine” that chooses the algorithm most adapted to the current market niche. We discuss some of the challenges of constructing such a switching engine and analyze some results from a particular realization.

TOPICS: Statistical methods, quantitative methods, security analysis and valuation

  • © 2009 Pageant Media Ltd
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Algorithm Switching: Co-Adaptation in the Market Ecology
Chris Stephens, Henri Waelbroeck
The Journal of Trading Jun 2009, 4 (3) 59-73; DOI: 10.3905/JOT.2009.4.3.059

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Algorithm Switching: Co-Adaptation in the Market Ecology
Chris Stephens, Henri Waelbroeck
The Journal of Trading Jun 2009, 4 (3) 59-73; DOI: 10.3905/JOT.2009.4.3.059
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  • Article
    • Abstract
    • A QUANTITATIVE FRAMEWORK FOR ALGORITHM SWITCHING
    • WHY ALGORITHM SWITCHING?
    • ADDRESSING STRATEGIC RISK IN TRADE EXECUTION
    • CONCLUSIONS
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