Technical Indicators, Entropy, and Fundamentals

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Despite having read some posted comments like: "Fundamentals are for loosers "[sic], (presumably means getting looser & looser all the time ;-)) personally i think that in the context of trying to write Equity Long-Short algos for Quantopian, i have found more benefit from experimenting with fundamentals data (Morningstar and the new FactSet databases) than i have from playing around with those old, trusted favorite (at least they were 20 years ago) "technical indicators" that we all know & love ... or don't. Actually i doubt that anyone has much hope of winning the daily Q Contest using moving average crossovers or similar .... although maybe i might be wrong. Anyway, in the context of Q algos, personally i do spend most of my time working with fundamentals data.

Nevertheless in a different context, outside of Q, i have been doing some experimentation looking at the Relative Entropy signatures of different technical indicators, mostly but not all well-known ones, and i have been rather surprised at how much they actually differ in their "information content", as measured by relative entropy. Of course this says nothing about the actual RELEVANCE of that info but, all other things being equal, the indicator with the higher Relative Entropy "should" contain more (hopefully useful) info.

Two questions now for friends & colleagues here at Q:
1) Have any of you who like using TA-type indicators used this sort of Relative Entropy approach here at Q with your ranking of indicators for algos? I think this is a perfectly reasonable, sensible, and probably useful question, although i'm a bit less sure about the next one.....

2) Picking up on several posts related to good selection of Fundamental data for input to Q algos, has anyone tried something similar for FUNDAMENTAL input data? Is this a useful / meaningful question? Even if it is not quite useful directly, then perhaps it may lead on to other useful ideas, in a similar way to how a consideration of Relative Entropy with regard to TA Indicators can certainly help us to design better indicators. Any thoughts / comments?

4 responses

Roy Mahady

Can I ask you for some information about relative Entropy. It sounds like it has some odd features for analyis

Tony Morland

Hi Roy & anyone else on Q:
I'm not active here for a while. There is currently too much of interest happening in the actual markets in real-time now, so i'm trading rather than playing with ideas. However in answer to your question / comment:
* Relative Entropy is a measure of information content. You can look it up on the internet in general if you are not familiar with the concept of Entropy. I have not seen anyone else using it with TA indicators, but i think that it does have some applicability.
* I don't understand what you are intending by your words: " .... odd features for analysis".
* I am always curious about new ideas, or applying not-so-new ideas in different ways, and hence my questions. However, to be honest, my personal experience is that most people make indicators too complicated. That may be intellectually interesting (like some of the other discussions here) but really, if you want to actually make money in trading, then my suggestion is not to complicate, but rather to simplify, and preferably get your TA indicators down to calculations based on as few bars as possible.

Cheers, best wishes for trading success in these busy times. T.

Roy Mahady

I researched it further and found an Interesting paper by the federal reserve about it. The equations are too complex for my mind to fadom. May I ask what type of indicators you prefer to use while charting. I am on MT4 and having some success at the moment combining indicators to formulate my signals. Appreciate your reply.

Tony Morland

Hi @Roy, and thanks for your reply.
Please can you send me the link to the paper about relative entropy and i will take a look if/when i can find time. My email is [email protected]

If you are using MT4, then my guess is that you are probably mostly trading Forex, is that right?
When you say that you are "having some success", do you mean in your actual live trading resultsor in your formulation of "signals"? If you mean indicator signals, then how do you define "success"?

There are quite a few people who write here in the Q forum and have "interesting" things to say, but i'm sure they never actually trade. Or if they do, then it is probably mostly just "paper trading" on Q. That's great if you want to submit algos for hedge fund use (via the contest), and this is a different skill set compared to actually trading your own account, but i think these skills do complement each other well.

Playing with all sorts of indicator development can be intellectually interesting, but if your main interest is in applied trading for actual (fun and) profit, then my main suggestions are 1) simplify everything as much as you can, and 2) make your indicator lengths = number of bars (in whatever time-frame you are using in your trading, irrespective of minutes, hours or days) as small, i.e. as few bars, as possible to reduce lag.

Things like moving averages are very useful for use as reference levels (e.g. 21-bar MA shows the MONTHLY trend if you are using EOD data) but very rarely useful in practical trading, except as filters, or as something to look at as a sort of "seat belt" on a chart if you ever get completely lost & confused. But when i see people using things like the crossover of two relatively long-term moving averages and imagining that could be a meaningful trading signal, then i think they are dreaming. Yes, it might have worked 30 years ago, and you can back-test that, but it probably doesn't work very well any more now.

Fundamentals are, i believe, a definite necessity if you want trade stocks.
If you take notice of fundamentals then it will prevent you from buying at the tops of wildly over-priced markets.

Ideas like Relative Entropy, Hurst Exponent, and all sorts of other things like that are interesting as background, but for applied trading, keep it simple.

If you want to play with conventional indicators, i.e. the ones that are in all the charting software packages etc, then that's good as a basic learning exercise, but if you want to actually trade, then my suggestions are:

*** Develop and test your OWN indicators, based on your own observation of real-live market action, not the standard "packaged" ones, and

*** Make them as short-period as you can.

Good luck & best wishes.
T.

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