Documentos de Académico
Documentos de Profesional
Documentos de Cultura
March 2012
Notice:
ml863@cornell.edu
2
SECTION I
The great divide
3
Is speed the real issue?
6
What is the new paradigm? (2/3)
Machines operate on an internal clock that is not
chrono based, but event based: The cycle.
A machine will complete a cycle at various chrono
rates, depending on the amount of information
involved in a particular instruction.
As it happens, HFT relies on machines, thus
measuring time in terms of events.
Thinking in volume-time is challenging for us
humans. But for a silicon trader, it is the natural way
to process information and engage in sequential,
strategic trading.
7
What is the new paradigm? (3/3)
0.2
Sampling by Volume
time allows for a
0.15
partial recovery of
Normality, IID
0.1
0.05
0
-5 -4 -3 -2 -1 0 1 2 3 4 5
Time clock Volume clock Normal Dist (same bins as Time clock)
9
SECTION II
More than speed
10
Example of Sequential Trading model
Pb (t )
B ( t ) E [ Si | t ] E [ Si | t ] S i
Pb (t )
Pg (t )
A(t ) E [ Si | t ] S E [ Si | t ]
Pg (t ) i
Pg (t ) Pb (t )
( t ) Si E[ Si | t ] E[Si | t ] Si
Pg (t ) Pb (t )
PIN
2
11
Little known species you should be aware of
Predatory algorithms are a special kind of informed
traders. Rather than possessing exogenous information
yet to be incorporated in the market price, they know
that their endogenous actions are likely to trigger a
microstructure mechanism, with foreseeable outcome.
Examples include:
Quote stuffing: Overwhelming an exchange with messages, with
the sole intention of slowing down competing algorithms.
Quote dangling: Sending quotes that force a squeezed trader to
chase a price against her interests.
Pack hunting: Predators hunting independently become aware
of each others activities, and form a pack in order to maximize
the chances of triggering a cascading effect.
12
Slow chess may be harder than you think (1/2)
OHara [2011] presents evidence of their disruptive activities.
Tesla tests the High Frequency AC Oscillator, giving twelve million volts
16
How can PIN be estimated High Frequency (1/2)
1. Trades or bars are grouped in equal volume buckets (e.g., 40,000
contracts).
2. For each trade or bar, Z% is classified as buy and (1-Z)% as sell (denoted
bulk classification). Caution: Not all the volume of a single trade or
bar is classified as buy or sell (some researchers are confused by this).
1
=
= 1 +1
1
= 1 =
= 1 +1
where is the index of the last time bar included in the volume bucket, Z
is the CDF of the standard normal distribution and is the estimate of the
standard derivation of price changes between time bars.
This procedure leads to better results than the tick rule, etc.
17
How can PIN be estimated High Frequency (2/2)
19
E-mini S&P500 futures on May 6th 2010
1 60000 By 11:56am, the realized
0.9
value of the VPIN metric
59000 was in the 10% tail of the
0.8
distribution (it exceeded a
0.7
58000
90% CDF(VPIN) critical
0.6
value). By 1:08pm, the
57000
realized value of VPIN was
Market Value
Probability
0.5
in the 5% tail of the
56000
0.4 distribution (over a 95%
0.3
55000
CDF(VPIN)). At 2:32pm the
crash begins according to
0.2
54000
the CFTC-SEC Report time
0.1
line. Link to video.
0 53000
5/6/10 2:31
5/6/10 5:28
5/6/10 8:27
5/6/10 9:16
5/6/10 9:40
5/6/10 9:55
5/6/10 13:56
5/6/10 15:19
5/6/10 10:18
5/6/10 10:35
5/6/10 10:52
5/6/10 11:07
5/6/10 11:18
5/6/10 11:36
5/6/10 11:51
5/6/10 12:12
5/6/10 12:40
5/6/10 13:12
5/6/10 13:29
5/6/10 14:09
5/6/10 14:17
5/6/10 14:24
5/6/10 14:34
5/6/10 14:39
5/6/10 14:43
5/6/10 14:45
5/6/10 14:48
5/6/10 14:52
5/6/10 14:56
5/6/10 15:03
5/6/10 15:09
5/6/10 15:29
5/6/10 15:41
5/6/10 15:49
5/6/10 15:57
5/6/10 16:02
5/6/10 19:37
Note: The May 6th 2010
Flash Crash is just one of
VPIN CDF(VPIN) Market value
hundreds of liquidity
events explained by VPIN!
20
Market Value
24
26
28
30
32
34
36
38
40
42
5/6/10 0:00
5/6/10 0:57
5/6/10 1:55
5/6/10 2:52
5/6/10 3:50
5/6/10 4:48
5/6/10 5:45
5/6/10 6:43
5/6/10 7:40
VIX
5/6/10 8:38
5/6/10 9:36
VPIN
5/6/10 10:33
5/6/10 11:31
Time
5/6/10 12:28
5/6/10 13:26
CDF(VPIN)
5/6/10 14:24
5/6/10 15:21
5/6/10 16:19
5/6/10 17:16
CDF(VIX)
5/6/10 18:14
5/6/10 19:12
5/6/10 20:09
5/6/10 21:07
5/6/10 22:04
5/6/10 23:02
5/7/10 0:00
0
1
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Probability
VIX on May 6th 2010
15:28pm.
impacted by it.
VIX didnt reach
21
at 9:30am, and reached a
of 89.53 On 10/24/2008).
Toxicity-induced volatility
There is a type of volatility that is not priced by VIX: Toxicity-
induced volatility.
Some characteristics:
Microstructural: This type volatility arises as a result of a failure in the
liquidity provision process. Although Macro news may initiate the flow
imbalance, it is MMs underestimation of VPIN that generates the toxic
inventory that ultimately forces them out of the market.
Endogenous: Unlike macro-volatility, this type of volatility can be
predicted, as liquidity providers come under stress gradually. There is a
lapse between the rise in VPIN and the liquidity crash, sometimes of
hours!
Short-term: The liquidity failure is typically short-lived. A price jump
will attract position takers, which will operate as tactical liquidity
providers.
22
Forecasting Toxicity-induced volatility (1/3)
An event e occurs every time that
while 1 < . We can index those
events as = 1, , , and record the volume bucket at
which crossed the threshold as
23
Forecasting Toxicity-induced volatility (2/3)
0.07 0.25 We have computed
two distributions of
0.06 probability: One for
0.05
0.6
indeed have
0.5 consequences in
terms of non-
0.4
standard MIR).
0.3
This is consistent
0.2
with most (red)
0.1
falling at
the tails of
0
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 unconstrained
CDF[MIR(e)]
MIR (blue).
25
SECTION V
Optimal Execution Horizon
26
Optimal Execution Strategies
Almgren and Chriss [2000] is one of the most widely used
models for execution.
27
Liquidity component
Suppose that we wish to disguise a trade for m contracts
within an execution horizon of V contracts. The impact on
VPIN will be:
+
=
= 2 1 1 +
We call footprint the displacement of the order imbalance
generated by our order, from 2 1 to
= 2 1 1 +
+ 1 2 1
28
Timing risk component
At the same time, we cannot wait an unlimited amount of
volume V to disguise m.
For a security price S with St.Dev of price changes over
volume buckets of size , the over a volume V is
> =1
29
Footprint minimization
A probabilistic loss function combines both components:
= 2 1 1 + + 1 2 1
. reaches a minimum when V
2
3
0
= 2 2 1
= 0
2 1
2 1
= + 2 1 + 1 2 1
30
Scenario 1: = 0.4
= 1,000, = 10,000, = 1,000, = 10,000, = 0.05 and =1.
contributes to
6,000 6000
narrowing the
trading spread.
4,000 4000
31
Scenario 2: = 0.5
= 1,000, = 10,000, = 1,000, = 10,000, = 0.05 and =1.
= 11,392
12,000 12000
We are buying in a
10,000 10000
balanced market. The
function is now
6,000 6000
convex decreasing,
without an inflexion
4,000 4000 point, because the
market is not leaning
2,000 2000 against us. The
optimal must be
0
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000
0
50,000
larger than in
Scenario 1, but
Volume horizon
limited by greater
timing risk with
Probabilistic Loss Liquidity component Timing component
increasing V.
32
Scenario 3: = 0.6
= 1,000, = 10,000, = 1,000, = 10,000, = 0.05 and =1.
= 9,817
12,000 12000
10,000 10000
Two forces contribute
to this outcome:
33
For all possible scenarios
= 1,000, = 10,000, = 1,000, = 10,000, = 0.05 and =1.
Optimal trading
14,000 horizon for a buy
order depends upon
12,000 the expected fraction
of buy orders in the
10,000
market. When all
Optimal volume horizon
8,000
orders are buys, is
1, while if all orders
6,000 are sells is 0.
34
THANKS FOR YOUR ATTENTION!
35
Bibliography (1/2)
36
Bibliography (2/2)
Easley, D., M. Lpez de Prado and M. OHara (2012b): Bulk Volume Classification,
Working paper: http://ssrn.com/abstract=1989555
Leinweber, D. (2009): Nerds on Wall Street: Math, Machines and Wired Markets,
Wiley.
Lpez de Prado, M. (2011): Advances in High Frequency Strategies, Ed.
Complutense University. http://tinyurl.com/hfpin
NANEX (2011): Strange Days June 8'th, 2011 - NatGas Algo,
http://www.nanex.net/StrangeDays/06082011.html
OHara, M. (2011): What is a quote?, Journal of Trading, Spring, 10-15.
The New York Times (2010): Ex-Physicist Leads Flash Crash Inquiry, 09/20.
37
Bio
Marcos M. Lpez de Prado is Head of Global Quant Research and High Frequency Futures Trading at Tudor Investment
Corp. Formerly, a Partner at PEAK6 Investments, Head of Quantitative Equity Research at UBS Wealth Management, and
a Portfolio Manager at Citadel Investment Group. He has been appointed Visiting Scholar at Cornell University, a
Postdoctoral Research Fellow of RCC at Harvard University and a Research Affiliate at Lawrence Berkeley National
Laboratory (U.S. Department of Energys Office of Science). He received a Ph.D. in Financial Economics (2003), Sc.D. in
Computational Finance (2011) from Complutense University and the National Graduation Award in Economics by the
Government of Spain (National Valedictorian, 1998).
Dr. Lpez de Prado is a member of the editorial board of the Journal of Investment Strategies (Risk Journals), and has
co-authored several academic papers with Professors Maureen OHara and David Easley (Cornell University), which are
listed among the most read in SSRN and have resulted in three international patent applications. His current Erds
number is 3 (with a valence of 2, through BaileyPomerance and ForemanKomjth), and would be happy to hear
from potential co-authors with an Erds number of 1.
38
Disclaimer
39