Automated FX Trading System Using ARL

Authors: M. Dempster & V. Leemans
Date: 2004 Website:

  • Adaptative Reinforcement Learning ⇒ ARL
  • 3 layers structure:

  • Machine Learning Algorithm:
    • Using Recurrent Reinforcement Learning (RRL)
  • Risk Management Overlay:
    • Restrain/shutdown trading when in high uncertainty.
  • Dynamic Utility Optimization:
    • Render selection of fixed meta-parameters useless.
    • Allow risk-return trade-off control by user.
Summary of previous work: Add link to Dempster - 2004 - Adaptative Systems For Foreing Exchange Trading [Quantitative Finance 4]
Find definition of the Sharpe Ratio ?
Previous work: Tarding system based on 2 superimposed AI algorithms: Add link to Dempster - 2002 - Intraday FX Trading: and evolutionary reinforcement learning approach
  • Machine Learning layer + Dynamaic optimization layer ⇒ Adaptative Reinforcement Learning.
Basic initial model: Add link to Moody & Saffell - 1999 - Minimizing downside risk via schochastic dynamic programming
Mathematical model and estimation procedure: add link to Moody & Saffell - 2001 - Learning to trade via direct reinforcement
  • Model used: \(F_t = sign\left( \sum\limits_{i=0}^M (w_{i,t} \cdot r_{t-i}) + w_{M+1,t} \cdot F_{t-1} + \nu_t\right)\)
  • \(F_t \in \{-1, 1\}\) is the position to take at time t.
  • \(w_t\) is the weight vector at time t.
  • \(\nu_t\) is the threshold at time t.
  • \(r_t = p_t - p_{t-1}\) are the raw return values at time t.
See all previous Dempster refs [1-5] for continuous time situation
  • At evrey trade we buy/sell 1 unit of the currency pair.
  • Profit at time T can be calculated as (ignoring interest rates):

\[\begin{align}P_T & = \sum\limits_{t=0}^T R_t \\ R_t & = F_{t-1} \cdot r_t - \delta |F_t - F_{t-1}|\end{align}\]

  • Where \(\delta\) is the transaction cost per trade.
  • We then define a differential sharpe ratio considering a moving average version of the classical sharpe ratio:

\[\begin{align}\hat{S}(t) & = \frac{A_t}{B_t} \\ A_t & = A_{t-1} + \eta(R_t - A_{t-1}) \\ B_t & = B_{t-1} + \eta (R_t^2 - B_{t-1})\end{align}\]

  • We then expand \(\hat{S}(t)\) into a Taylor serie in \(\eta\), and we can consider the first derivative as an instantaneous performance measure:

\[D_t = {\frac{d\hat{S}(t)}{d\eta}}_{|\eta=0} = \frac{B_{t-1}\Delta A_t - \frac 12 A_{t-1} \Delta B_t}{(B_{t-1} - A_{t-1}^2)^{\frac 32}}\]

  • We then use a simple gradient descent method to update the weights: \(w_{i,t} = w_{i,t-1} + \rho \Delta w_{i,t}\)
  • In case of online learning we can consider only the term that depends on the most recent return \(R_t\), so we get:

\[\Delta w_{i,t} = \frac{dD_t}{dw_i} \approx \frac{dD_t}{dR_t} \left( \frac{dR_t}{dF_t} \cdot \frac{dF_t}{dw_{i,t}} + \frac{dR_t}{dF_{t-1}} \cdot \frac{dF_{t-1}}{dw_{i,t-1}}\right)\]

  • Considering that the neural network is recurrent, we can get:

\[\frac{dF_t}{dw_{i,t}} \approx \frac{\partial F_t}{\partial w_{i,t}} + \frac{\partial F_t}{\partial F_{t-1}} \cdot \frac{dF_{t-1}}{dw_{i,t}}\]

RRL are very interesing for rolling window usage: add link to [Gold - 2003 - FX trading via recurrent reinforcement learning] and [Dempster - 2001 - Realtime adaptative trading system using genetic programming]
  • The system is then trained on \(n_e = 10\) epochs on training set of length \(L_{train} = 2000\) ticks [optimal value].
  • Then we test it on test set of length \(L_{test} = 500\) ticks [optimal value].
  • Extended to take into account other inputs such as signals from 14 technical indicators. ⇒ This didn't improve the results.
See [Dempster - 2001 - Computational learning techniques for intraday FX trading using popular technical indicators
  • During training phase the transaction cost \(\delta\) is left as a tuning parameter.
  • To prevent too big weights, all weights are rescaled by a factor \(f \lt 1\) as soon as a threshold value is hit.
  • Improved position updating scheme: recalculating the output \(F_t\) twice:
    1. As before
    2. After the weights are updated ⇒ provide a more accurate value which might be different.
  • Build a trailing stop-loss which is always adjusted x points under or above the best price reached during the life of a position.
  • If a position is closed because of the stoploss, then a cool-down period [⇒ using 1 minute] is used before trading again.
  • This layer can evaluate the strength of the signal received from the NN using the non-thresholded value (inside the sign() function).
  • A threshold y can be provided by the optimization layer to only enter a position when we have an higher certainty.
  • A maximum draw-down system [parameter z] is implemented to prevent complete failure of the trading system.
  • Definition of the risk measure:

\[\Sigma = \frac{\sum_{i=0}^N (R_i)^2 I\{R_i \lt 0\}}{\sum_{i=0}^N (R_i)^2 I\{R_i \gt 0\}}\]

Here \(R_i\) is the raw return at time i: \(R_i = W_i - W_{i-1}\), with \(W_i\) the cumulative profit at time i.

  • Then we define the utility function: \(U(\bar{R},\Sigma,\nu) = a \cdot (1 - \nu) \bar{R} - \nu \cdot \Sigma\), with:
    • \(\nu\): Risk aversion parameter.
    • \(\bar{R} = \frac{W_N}{N}\) : average profit per frequency interval.
Standard theoritical work on risk measure (Not applicable above): [Ruszczynski - 2002 - Dual Stochastic dominance and related mean-risk models] and [Ruszczynski - 2003 - Frontiers of stochastically non-dominated portfolios]
  • The parameter optimization problem becomes:

\[\max_{\delta, \eta, \rho, x, y} U(\bar{R},\Sigma : \delta, \eta, \rho, x, y)\]

⇒ Implemented as a one-at-a-time random search optimization (using 15 random evaluation around current value for each parameter).

Provide typical range of the parameters here.
  • Tested with the EURUSD pair:
    • Frequency of 1 minute from January 200 to January 2002.
    • Spread of 2 pips.
  • Trading between 9 am and 5 pm (london time)
  • Interdealer platform: EBS / Reuters3000
  • Used risk aversion value \(\nu = 0.5\)
  • ⇒ Earned 5104 pips over 2 years
  • Future work:
    • In [2,7] it has demonstrated that order book or order flow information could enhance the perfs.
    • Risk management layer could control multiple trading systems for different currencies.
  • public/books/dempster_2004_automated_fx_trading_system_using_arl/intro.txt
  • Last modified: 2020/07/10 12:11
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