Exploiting the potential of a directional changes-based trading algorithm in the stock market

Han Ao and Munan Li

Finance Research Letters, 2024, vol. 60, issue C

Abstract: The performance of Directional Change based trading algorithms may be distorted due to omitting the difference between theoretical and actual Directional Change confirmations. The impact of the difference could be so vast so that trading algorithms are seemingly unusable. Applying theoretical confirmations instead of actual ones, we show the potential of these trading algorithms. Among 100 stocks, the number of overall-profit gains has improved from 61 to a theoretical 100, and a theoretical daily 0.1 % rate of return could be expected. The algorithm's overall return is related to the frequency of its trades. When designing a trading algorithm, the distortion should be considered. A threshold that minimizes the difference between actual and theoretical confirmations should be preferred so that the actual results could be closer to its theoretical values.

Keywords: Directional change; Scaling law; Algorithm trading (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:60:y:2024:i:c:s1544612323013089

DOI: 10.1016/j.frl.2023.104936

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