Richard Brown
While the mass adoption of machine-readable news in trading environments is still in its
early stages, there are a number of techniques that can be used to significantly improve
trading performance, both in offensive as well as in defensive strategies. These tech-
niques range from simple circuit breakers or wolf detection systems (defensive) to
systems that will exploit the volatility surrounding significant news items, or those that
will predict the direction and magnitude of a price movement (offensive).
Over the last few years, there has been a substantially larger amount of research on the
use of news for trading and investment strategies. The research has been less conclusive
on signals for returns, however. This has in large part been due to two factors. First,
there has traditionally been a lack of comprehensive metrics and metadata, which can be
used to determine the direction, magnitude, and duration of such movements. Second,
logic suggests that if there is a killer strategy for doing this, one is more likely to trade on
it than to tell the whole world about it.
So, how can one incorporate news into algorithmic strategies to improve
trading performance?
One of the more common and easily implemented uses of machine-readable news in a
trading environment is to use the news feed as a circuit breaker for algorithms. This
approach would stop your algorithm from its current course of action when news is
published on a particular company. For example, if you are buying 100,000 shares of
IBM using a certain algorithm and news comes out on IBM, a news-tripped circuit
breaker would stop your continued purchase until you determine (or your machine
determines in more advanced approaches) whether or not the information in the news
affects your decision. Some also refer to this approach as ‘‘wolf detection’’—someone
has better information than you do and can exploit the market’s, or your, ignorance.
In the above example where further automated trades on IBM are stopped when news
is published, one can imagine a situation whereby the circuit breaker is tripped too often.
This may happen for a stock that is frequently in the news or with others that are often
The Handbook of News Analytics in Finance Edited by L. Mitra and G. Mitra
#2011 John Wiley & Sons