Elsevier

Applied Soft Computing

Volume 84, November 2019, 105713
Applied Soft Computing

Grammatical Evolution-based ensembles for algorithmic trading

https://doi.org/10.1016/j.asoc.2019.105713Get rights and content

Highlights

  • Grammatical Evolution-based Ensembles adapt to structural change.

  • Constant update of rules implicitly optimized for the long run causes overtrading.

  • Limiting the number of purchase/sale orders is crucial for adaptive solutions.

  • The inertia component of the voting system is key to control transaction costs.

Abstract

The literature on trading algorithms based on Grammatical Evolution commonly presents solutions that rely on static approaches. Given the prevalence of structural change in financial time series, that implies that the rules might have to be updated at predefined time intervals. We introduce an alternative solution based on an ensemble of models which are trained using a sliding window. The structure of the ensemble combines the flexibility required to adapt to structural changes with the need to control for the excessive transaction costs associated with over-trading. The performance of the algorithm is benchmarked against five different comparable strategies that include the traditional static approach, the generation of trading rules that are used for single time period and are subsequently discarded, and three alternatives based on ensembles with different voting schemes. The experimental results, based on market data, show that the suggested approach offers very competitive results against comparable solutions and highlight the importance of containing transaction costs.

Introduction

Stock market is highly dynamic and subject to structural changes. Trading rules might be very profitable during specific periods of time and progressively lose their effectiveness as market dynamics evolve over time. This requires developing approaches capable of detecting and adapting to these structural changes.

Since Allen and Karjalainen [1] published their seminal piece on evolution of trading rules using Genetic Programming (GP), many authors have made related contributions either based on the same technique, or Grammatical Evolution (GE). Among them, [2], [3], [4], [5], [6], [7], [8], [9].

Most of these contributions generate investment rules based on a combination of raw market data and technical indicators and, unlike related approaches that use genetic algorithms or evolution strategies to optimize predefined rules, these have the advantage of creating flexible structures automatically. Other algorithms within the evolutionary computation framework, like the ones discussed in [10], [11], would be readily applicable to related financial problems like mean–variance portfolio optimization, but would require significant adaptations and domain expertise to evolve the functional trees that GP and GE generate.

A common limitation is that it is often the case that the methods are static, and do not take into account structural changes. Given that this phenomenon is very prevalent in financial time series, decision rules are commonly derived from market environments that do not hold for long periods.

The problem of adjusting to structural changes is that we must choose between two opposite extremes: keeping the same model over time, or updating it constantly. Even though the second might seem, at least in principle, more appropriate, there is a possibility that the constant change in the model will have undesirable consequences due to transaction costs. The evolutionary process of GP/GE considers commissions within the fitness function, and that makes it select rules that generate a limited number of signals. However, it is possible that constant model updates might interfere with that endogenous control mechanism of the number of purchase and sale orders.

This paper introduces a dynamic trading system based on the use of ensembles and GE. The approach combines the possibility of changing the model, as a reaction to changes in the price generation mechanism, with an inertia component that mitigates the consequences of overtrading.

An ensemble in this context can be compared to a collegiate decision committee in which the votes of several judges are combined to arrive at a final decision [12]. The idea behind this method is to take advantage of the good local behavior of each of the judges, in order to increase the accuracy and reliability in the environment of a global scenario [13]. In Statistics and Automatic Learning, ensemble methods use multiple learning algorithms to obtain a better predictive performance than that which could be obtained from any of the constituent learning algorithms separately [14], [15], [16]. Unlike a statistical set, which is generally infinite, an automatic learning set consists of only a finite set of alternative models but typically allows a much more flexible structure to exist by combining those alternatives.

It is worth noting that the solution that we introduce integrates the output of several trading rules to generate a combined recommendation that makes financial sense in dynamic environments. This differs from other algorithmic solutions that rely on ensembles of models to tackle more standard classification or regression tasks, such as [17], [18]. The aim of trading algorithms is obtaining profitable rules, and one might consider that this task implicitly requires solving two problems. The first one would involve predicting market movements based on past information, for instance, it might predict whether the market is expected to go up, down, or remain stable, while the second one would be exploiting the previous information to obtain investment recommendations. Algorithms like the ones that we just mentioned might well excel at the first task, but lack the second layer.

Joint solutions are widely used in Artificial Intelligence, especially in neural networks (Hansen and Salamon [19]; Perrone and Cooper [20]; Opitz and Shavlik [21]). In these cases, several classifiers, usually neural networks with different topologies and/or parameters, are used to classify the same input pattern and their votes are combined using a specific rule such as majority, arithmetic mean, weighted average, etc. However, there are other works related to GP, such as Grosan et al. [22], that use the technique of ensembles in the context of obtaining investment models in financial markets. In this work, as we will discuss, the decisions committees are formed by different trading rules obtained using GE as the basic optimization algorithm and a sliding window.

The structure of the rest of the document is as follows: the next section describes the main references on GE for algorithmic trading and Evolutionary Computation (EC) based on adaptive approaches. Then, Section 3 describes the proposed approach. That will be followed by Section 4, focused on the experimental analysis. Finally, Section 5 will be devoted to summary and conclusions.

Section snippets

Previous work

The academic literature on GE for algorithmic trading is not as ample as the one based on GP. However, there are a number of relevant contributions that deserve to be mentioned.

One of the first works, in which evolutionary grammars are used to discover trading rules based on technical indicators, is that of Brabazon and O’Neill [23]. These authors explored the possibility of using this technique to generate investment rules for the money market. In their study, they combined a small set of

Proposed approach

This section starts with an introduction to the standard approach to evolve trading rules with flexible representation using GE. As it was mentioned before, the standard method suffers from some limitations in a domain where structural change is prevalent. For this reason, we then introduce an adaptive ensemble approach designed to overcome them and improve performance.

Experimental analysis

In this section we describe the experimental setup, including elements like the dataset, the experimental protocol and the parametrization, followed by the presentation and discussion of the results.

Summary and conclusions

The evolution of trading rules with flexible representation using Grammatical Evolution in its standard version involves obtaining a single rule based on a training period that is subsequently used to generate recommendations over time. Given the prevalence of structural change in financial series, this poses a problem.

In this paper we suggested using an ensemble of trading rules obtained using Grammatical Evolution on a sliding window. The system has a critical component, the voting mechanism,

Declaration of Competing Interest

No author associated with this paper has disclosed any potential or pertinent conflicts which may be perceived to have impending conflict with this work. For full disclosure statements refer to https://doi.org/10.1016/j.asoc.2019.105713.

Acknowledgment

The authors would like to acknowledge the financial support of the Spanish Ministry of Science, Innovation and Universities under project PGC2018-096849-B-I00 (MCFin).

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