Hello,
welcome back to Papers with Backtest podcast.
Today we dive into another Algo trading research paper.
Yeah,
looking forward to this one.
So,
you know,
for hedge fund managers,
it's this constant grind,
isn't it?
The pressure to beat the benchmark.
Oh,
absolutely.
Fall behind and investors,
well,
they might start looking elsewhere.
It's tough out there,
especially if you lean towards the efficient market hypothesis that beating the market consistently is basically impossible,
or at least very,
very difficult.
Right.
Which leads to the big question,
where do you find that edge,
that alpha?
Exactly.
And this paper,
it digs into alternative data as maybe one answer for the pros.
Alternative data.
So we're talking about information that's unique,
not your standard market data fees you get everywhere.
Okay,
so not just stock prices and P.E.
ratios.
No,
think outside the box,
like satellite images,
maybe tracking cars in parking lots,
or sensor data from supply chains.
Interesting.
The.
But this paper,
it really zooms in on web data because it's just vast and so diverse.
Web data.
Right.
So company websites,
product prices online,
forums,
news sites.
Yeah.
It's potentially huge.
It is.
And apparently investors are noticing big time.
The paper mentions projections over $7 billion being invested in alt data and the tech to handle it by 2020.
$7 billion.
Wow.
That's serious commitment.
it.
people really believe there's value there.
Definitely.
The core idea really is that digging into this non-traditional data can uncover insights you just wouldn't get otherwise.
You know,
find things before they show up in regular financial reports.
Giving you a jump on the market potentially.
That's the goal.
It's about generating that unique alpha,
that performance edge.
Sophisticated investors see it as a way to really complement their traditional analysis.
Okay.
So let's talk specifics.
How does this messy web data actually turn into like trading rules?
The paper mentions aggregating corporate operational data.
What does that look like?
Well,
imagine scraping data continuously from,
say,
job boards across an entire industry.
Not just one company,
but all its competitors,
too.
If you suddenly see one company ramping up hiring way more than others,
that could be an early signal maybe of growth or a new project kicking off.
Ah,
I see.
So a potential trading signal based on aggregated hiring trends.
Exactly.
It's about spotting those relative changes,
those anomalies derived from the web.
What about price monitoring?
The paper mentions tracking prices and inventory globally.
How's that different from just,
you know,
inflation stats?
It's much more granular in real time.
Think about tracking the online price of a specific semiconductor or lumber prices on supplier websites worldwide.
Right.
If you see prices for a key component spiking up consistently and maybe inventories dropping at the same time,
that could signal supply issues or rising costs.
before it hits the company's earnings report.
It points towards potential margin pressure.
So a trading rule might be what?
Shorting companies,
heavily reliant on that component if the price crosses a certain threshold.
Precisely.
Or maybe going long on the suppliers if they seem to have pricing power.
It's about translating those real-time web signals into actionable trade ideas.
Then there's sentiment analysis.
Using AI,
machine learning,
NLP,
all that stuff to gauge the buzz online.
Yeah,
this one's...
Fascinating,
but also potentially tricky.
How so?
Well,
the idea is simple enough.
Track what people are saying online about a stock or product.
Use AI to figure out if the chatter is positive or negative and how intense it is.
Okay.
A big sustained surge in negative sentiment,
especially if it seems credible,
might predict the stock price heading down.
Might?
Yeah,
might is the key word.
Online sentiment can be noisy,
easily manipulated sometimes.
So you need
Really robust filters.
You can't just trade on every tweet,
obviously.
Right.
You need to separate the signal from the noise.
Makes sense.
Okay.
So you develop these potential rules,
hiring trends,
price spikes,
sentiment shifts.
How do you know if they actually work before risking real capital?
That's where backtesting is absolutely crucial.
You take your rule and run it against historical data.
See how it would have performed in the past.
The paper mentions some key metrics for evaluating that performance.
Not just profit,
right?
Definitely not just profit.
or absolute return as they call it you need context that's where alpha comes in did your strategy actually beat its benchmark did it provide an edge so alpha is the secret sauce measure kind of yeah then there's beta how much did your strategy move with the overall market you
need to understand the systemic risk you took okay and standard deviation tells you about volatility how bumpy was the ride was it a smooth gain or wild swings right risk matters hugely
Which leads to risk-adjusted metrics like the Sharpe ratio return versus total risk.
And the Sortino ratio,
which is similar but focuses specifically on downside risk,
the bad kind of volatility.
Sortino.
I like that.
Only penalizes for losses.
Exactly.
And R-squared tells you how much of your performance was just the market moving versus something unique your strategy did.
And critically,
you need a relevant benchmark for comparison.
Always.
So a whole suite of metrics to judge if a web data strategy holds water based on past data.
Yes.
It's about rigorous evaluation.
But even that depends heavily on one more thing.
Data quality.
Garbage in,
garbage out right.
Ah,
yeah.
If the web data you scraped was wrong or incomplete.
Then your backtest results are meaningless.
Worse than useless,
actually,
because they give false confidence.
So you need clean,
reliable data history.
The paper mentions an audit trail.
Absolutely essential.
You need to be able to track where your data came from,
how it was processed,
and be able to recreate it.
It ensures integrity and reproducibility.
If you can't trust the data underlying the backtest,
you can't trust the strategy.
Makes perfect sense.
So,
it's quite a process then.
Find the right web data,
figure out a smart trading rule,
backtest it rigorously using the right metrics,
and make absolutely sure your data is solid.
That's the path.
It requires discipline,
good tech,
and...
healthy dose of skepticism.
But the potential payoff finding those unique insights from the web is why so many are investing heavily in it.
It really highlights how the search for alpha is pushing into new complex territories.
Fascinating stuff.
It really is.
The digital footprint is just massive.
Thank you for tuning in to Papers with Backtest podcast.
We hope today's episode gave you useful insights.
Join us next time as we break down more research.
And for more papers and backtests,
find us at https.paperswithbacktest.com.
Happy trading.