Trading Evolved

More than any other technological change, the rise of Python in the past years has dramatically leveled the playing field in systematic trading. In just a matter of years, Python has emerged as one of the most powerful, versatile and widely used tool for systematic traders.

When I started my journey into Python land, I was struck by two key insights. These two realizations and what they imply prompted me to write a new book, which not only is a whole new type of book for me, but also by far the largest book I have authored.

First, I was incredibly impressed by the power of this language. I have been programming computers since I was ten years old, and it feels very odd to be impressed by a programming language. After all, a programming language is just a tool, and you rarely get impressed by a new hammer.

But Python really is amazing. Compared to other environments, it’s very easy to learn Python and you can get financial analytical tasks done very quickly. Tasks which would take hundreds of lines of code in C# and similar can be done in a single line.

I really do believe that anyone can learn Python and that it is an extremely useful skill for anyone working with backtesting and implementation of trading ideas.

But my second realization was that documentation about Python was very poor. Almost all documentation, books and articles assume that you already know pretty much everything. I didn’t find the online forums particularly helpful either, with most replies simply pointing out that the poster should do his homework before asking silly questions.

The problem I saw with Python is that there was a clear lack of understandable documentation. I found some great books on Python, but they tend to assume that you’re already a programmer, or a data scientist. That’s fine for people like me, who already have a background in such things, but it doesn’t help newcomers to the field.

I wrote this book for two reasons. First, to fill this gap. To open up the field of Python backtesting to all the traders out there using inferior tools. I want to broaden the appeal of Python and get everyone from advanced algo traders to happy hobby traders in on the game.

Trading Evolved does not assume any previous programming knowledge. At all. It does assume that you are sufficiently interested in trading that you are willing to put in a bit of time and effort.

This book is unlike any of my previous books. This book aims to take you from zero to a level of knowledge about Python backtesting that can make you dangerous out there. But this is not just a programming book. This is a trading book.

My previous books explained one trading strategy per book. This book explains many trading strategies. While my previous books tried to explain all the rules in enough detail that you could try to replicate it at home, Trading Evolved actually shows you all of the source code.

I hope you’ll like the book, and I very much appreciate if you would do an Amazon review.

Kindle or Paperback

Trading Evolved will be available in both Kindle and Paperback. So which one should you pick?

This is a big book, at nearly 500 pages and it’s packed with information. I suspect that most people will want to be able to quickly flip back and forth in the book, looking up syntax and information. They probably want to put sticky notes in there, scribble comments and underline. It’s a book that you will most likely read more than once. Perhaps even read a chapter or two, and then move to a computer to try out your new skills. Those things are clearly easier with a paperback.

I read a lot of books, mostly on my Kindle device. This kind of book though, I would personally prefer to have as a paperback on my desk.

For this reason, I have differentiated the pricing significantly. The paperback will have a premium price tag. This is a unique book, with content not found in any other book, and it is a substantial book with nearly 500 pages packed with practical, in-depth content, which took me a year to write. But I will price the Kindle version at just $9.99, to reflect the fact that I personally see the hardcover as more useful. I will also allow those who bought the paperback version to buy the Kindle in addition for just $2.99, so that you can have both versions.

I hope you will find this a fair proposition.

Updates and Errata

As expected, some updates are necessary. In a book like this, it’s impossible to get everything perfect for all kinds of environments and to predict ever updating third party software.

You will find an updating article of issues and solutions here.

Downloads

There are two separate downloads for this book. The source code file contains all code samples used in the book, while the data file contains random data generated for testing, as discussed in the book.

Table of Contents

1      About this Book                                                                          1

The Trading Strategies in this Book                                                                                                                       2

How to Read this Book                                                                                                                                               3

How this book is written                                                                                                                                            4

How the code is written                                                                                                                                             5

Errata                                                                                                                                                                                 5

Support                                                                                                                                                                             6

2      Systematic Trading                                                                   7

Trading Approach Validation                                                                                                                                   7

Scientific Approach                                                                                                                                                      8

Consistent Methodology                                                                                                                                        10

Time Management                                                                                                                                                     11

3      Developing Trading Models                                                13

Model Purpose                                                                                                                                                            13

Rules and Variations                                                                                                                                                 15

Handling Data                                                                                                                                                             17

Asset Class                                                                                                                                                                    18

Investment Universe                                                                                                                                                19

Allocation and Risk Level                                                                                                                                        20

Entry and Exit Rules                                                                                                                                                  20

Rebalancing                                                                                                                                                                  21

4      Financial Risk                                                                            23

Quantifying Risk                                                                                                                                                         23

Mark to Market                                                                                                                                                            25

Common Risk Fallacies                                                                                                                                            26

Risk as Currency to Buy Performance                                                                                                                 30

5      Introduction to Python                                                       34

Some Assembly Required                                                                                                                                        34

Python Emerges as the Logical Choice                                                                                                              36

Programming Teaching Approach                                                                                                                       37

Installing Python on your Computer                                                                                                                 38

Let’s Run Some Code                                                                                                                                                39

Working with Jupyter Notebook                                                                                                                          46

Dictionary Lookup                                                                                                                                                     47

Conditional Logic                                                                                                                                                       50

Common Mistakes                                                                                                                                                     51

Installing Libraries                                                                                                                                                     54

6      Bring out the Pandas                                                             57

Documentation and Help                                                                                                                                       61

Simple Python Simulation                                                                                                                                      65

Making a Correlation Graph                                                                                                                                  71

Prettier Graphs                                                                                                                                                            76

7      Backtesting Trading Strategies                                        84

Python Backtesting Engines                                                                                                                                   86

Zipline and Quantopian                                                                                                                                          88

Pros and Cons                                                                                                                                                              90

Installing Zipline                                                                                                                                                        91

Problems with Installing Zipline                                                                                                                          95

Zipline and Data                                                                                                                                                         95

Ingesting the Quandl Bundle                                                                                                                                 97

Installing Useful Libraries                                                                                                                                       99

Where to Write Backtest Algos                                                                                                                            100

Your First Zipline Backtest                                                                                                                                   101

Portfolio Backtest                                                                                                                                                    108

Data Used for this Book                                                                                                                                         115

8      Analyzing Backtest Results                                               116

Installing PyFolio                                                                                                                                                    116

Portfolio Algorithm to Analyze                                                                                                                           117

Analyzing Performance with PyFolio                                                                                                               122

Custom Analysis                                                                                                                                                       129

Day Snapshot                                                                                                                                                            131

Custom Time Series Analytics                                                                                                                             135

9      Exchange Traded Funds                                                      142

The Good                                                                                                                                                                    142

The Bad                                                                                                                                                                        143

The Worst                                                                                                                                                                    149

Shorting Exchange Traded Funds                                                                                                                      155

10   Constructing ETF Models                                                   158

Asset Allocation Model                                                                                                                                          160

11   Equities                                                                                      167

The Most Difficult Asset Class                                                                                                                             167

A word on Methodology                                                                                                                                        169

Equity Investment Universe                                                                                                                                169

Dividends                                                                                                                                                                    171

12   Systematic Momentum                                                         174

Replicating this Model                                                                                                                                           174

Momentum Model Rules Summary                                                                                                                  175

Investment Universe                                                                                                                                              176

Momentum Ranking                                                                                                                                               177

Position Allocation                                                                                                                                                  185

Momentum Model Logic                                                                                                                                       187

Downside Protection                                                                                                                                              190

Momentum Model Source Code                                                                                                                        192

Performance                                                                                                                                                               204

Equity Momentum Model Results                                                                                                                    205

13   Futures Models                                                                      211

Futures Basics                                                                                                                                                           212

Futures Mechanics and Terminology                                                                                                               214

Futures and Currency Exposure                                                                                                                         218

Futures and Leverage                                                                                                                                             219

14   Futures Modeling and Backtesting                               221

Continuations                                                                                                                                                           226

Zipline Continuation Behavior                                                                                                                           229

Contracts, Continuations and Rolling                                                                                                             230

15   Futures Trend Following                                                   233

Principles of Trend Following                                                                                                                             234

Revisiting the Core Trend Model                                                                                                                       236

Model Purpose                                                                                                                                                          237

Investment Universe                                                                                                                                              238

Trading Frequency                                                                                                                                                  239

Position Allocation                                                                                                                                                  239

Entry Rules                                                                                                                                                                 244

Exit Rules                                                                                                                                                                     245

Costs and Slippage                                                                                                                                                  246

Interest on Liquidity                                                                                                                                               247

Trend Model Source Code                                                                                                                                    248

Core Trend Model Results                                                                                                                                    260

16   Time Return Trend Model                                                   266

Investment Universe                                                                                                                                              267

Trading Frequency                                                                                                                                                  267

Position Allocation                                                                                                                                                  268

Trading Rules                                                                                                                                                             268

Dynamic Performance Chart                                                                                                                               269

Time Return Source Code                                                                                                                                     270

Time Return Model Performance                                                                                                                       275

Rebalancing                                                                                                                                                                281

17   Counter Trend Trading                                                       283

Counter Model Logic                                                                                                                                              285

Quantifying Pullbacks                                                                                                                                            287

Rules Summary                                                                                                                                                         288

Counter Trend Source Code                                                                                                                                289

Counter Trend Results                                                                                                                                           293

18   Trading the Curve                                                                 298

Term Structure Basics                                                                                                                                             298

Quantifying Term Structure Effect                                                                                                                     302

Curve Model Logic                                                                                                                                                   304

Curve Trading Source Code                                                                                                                                 306

Curve Trading Results                                                                                                                                            314

Model Considerations                                                                                                                                           317

19   Comparing and Combining Models                                  319

Combining the Models                                                                                                                                          322

Implementing a Portfolio of Models                                                                                                                325

20   Performance Visualization and Combinations          327

Storing Model Results                                                                                                                                            327

How the Model Performance Analysis was done                                                                                         328

How the Combined Portfolio Analysis was done                                                                                        332

21   You can’t beat all of the Monkeys all of the Time   336

Mr. Bubbles goes to Wall Street                                                                                                                          338

The Problem is with the Index                                                                                                                            346

Finding Mr. Bubbles                                                                                                                                                349

22   Guest Chapter: Measuring Relative Performance     353

23   Importing your Data                                                             370

Making a Bundle                                                                                                                                                       371

Zipline and Futures Data                                                                                                                                      381

Futures Data Bundle                                                                                                                                               383

Patching the Framework                                                                                                                                       392

24   Data and Databases                                                               394

Your Very Own Securities Database                                                                                                                  397

Installing MySQL Server                                                                                                                                        398

Making an Equities Time-Series Table                                                                                                            400

Populating the Database                                                                                                                                      402

Querying the Database                                                                                                                                          408

Making a Database Bundle                                                                                                                                   411

25   Final Words – Path Forward                                               415

Build Your Own Models                                                                                                                                         415

Other Backtesting Engines                                                                                                                                   416

How to Make Money in the Markets                                                                                                                 418

References                                                                                      419

Index  420