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Title: From Quantitative Finance ToIntelligent Finance Financial Information Fusion, Multilevel Process Ana

From Quantitative Finance To Intelligent
Finance --- Financial Information Fusion,
Multilevel Process Analysis, and Dynamic
Portfolio Management
International Workshop on Forecasting and Risk
Management IWFRM06
  • Prof Dr PAN Heping, Director
  • International Institute for Financial Prediction
  • Australia and China, URL, Email
  • IIFP China, Finance Research Centre of China
    (FRCC) Southwest University of Finance and
    Economics (SWUFE) IIFP Australia School of
    Information Technology and Mathematical Sciences
  • University of Ballarat, Mt Helen, 3353, Victoria,
  • Phone/Fax 61-3-5327-9860/-9289, Mobile

Key Points
  • Finance has evolved along a natural sequence of
    stages from Economic Finance through
    Quantitative Finance now to Intelligent
    Finance These developments are still coexistent
    and will remain so.
  • Intelligent Finance as a science aims to
    understand the global financial markets as the
    world most complicated social complex systems of
    intelligent agents investors, traders and
  • Intelligent Finance as an engineering aims to
    develop consistently profitable trading systems
    operating in global financial markets stocks,
    bonds, currencies, commodities and their
    derivatives futures and options.
  • Intelligent Finance integrates information flows
    from multiple perspectives Fundamental,
    Technical and Strategic Analysis into a coherent
    framework which can help investors/traders to
    detect, anticipate and capture profitable
    investing/trading opportunities in real time and
    on multiple time frames, and manage portfolios

Key Points
  • Intelligent Finance represents a philosophy that
  • The market is always in a state of swings between
    efficient and inefficient modes, on multiple
    levels of time scale
  • It is possible to go beyond EMH to study the
    dynamic evolving processes of the market between
    equilibrium, non-equilibrium and
    far-from-equilibrium, in multiple dimensions
  • There are robust dynamic patterns in the evolving
    processes, most of them are quite abstract,
    beyond common sense, and against human nature,
    due to bounded rationality, limited resources,
    and very human nature of market participants.
  • It is possible to break the symmetry between
    profit and loss by exploiting such robust dynamic
    patterns using a trading system.

  • Evolution of Academic Finance vs Professional
    Finance - Economic Finance, Quantitative Finance
    and Intelligent Finance - Fundamental Analysis
    and Investors - Technical Analysis and Traders -
    Strategic Analysis and Players
  • Financial Information Fusion (FIF) - Information
    Source Identification - Historical Process
    Analysis - Current Situation Assessment - Future
    Scenario Projection - Market Selection and
  • Multilevel Process Analysis (MPA) - Multilevel
    Fractal Decomposition of Financial Time Series -
    Multilevel Structural Time Series Models -
    Multilevel Stochastic Differential Equations -
    Multilevel Dynamic Pattern Recognition -
    Multimarket Multilevel Stochastic Dynamics
  • Dynamic Portfolio Management (DPM) - Stocks,
    Bonds, Interest Rates (and Forex Rates and
    Commodity Prices) - Influence Factors - Phases of
    Trends, Cycles and Seasonality and Market
    Timing - Multilevel Multiperiod Portfolio
    Theory - Multilevel Value at Risk in General and
    Extreme Conditions
  • Conclusions and Outlook

1. Evolution of Academic vs Professional Finance
  • Finance to Economy of a nation is like the blood
    circulation system and the central nervous system
    to a living animal body. Finance not only
    circulate the money (energy) through the economy,
    but also reflects the information about the
  • Finance vs Economics are inherently connected,
    but now quite different disciplines, each with
    its own substantially developed methodologies. It
    is inappropriate and even harmful to try to apply
    economic principles to finance problems. E.g.
    equilibrium vs disequilibrium, - feedback loops.
  • Academic vs Professional Finance are inherently
    connected, but now quite different schools of
    thought, each with its own substantially
    developed methodologies. Academic Finance
    focuses more on financial governance and risk
    management, while Professional Finance is more
    concerned with profit making while keeping risk
    checked only as a necessary condition.

From Economic Thru Quantitative to Intelligent
  • Finance has evolved along a natural sequence of
    development stages from Economic Finance through
    Quantitative Finance now to Intelligent Finance.
    Of course these three developments are still
    coexistent and will remain so for the foreseeable
  • Economic Finance refers to the traditional and
    still mainstream finance which originates as a
    coherent part of economics, including currency,
    banking and financial markets from
    macroeconomics, and corporate finance, accounting
    and insurance from microeconomics and business
  • Quantitative Finance has aimed at quantitative
    analysis of every part of finance and developing
    mathematical and computational models.
  • Intelligent Finance takes the finance of a nation
    or the whole mankind as a living complex system
    made up of intelligent agents and aims at
    developing intelligent finance systems for
    banking, investing, trading and other financial

Origin of Quantitative Finance Problem of
  • Theorie de Speculation by Bachelier (1900)
    Brownian Motion, Wiener Process, Random Walk
  • Efficient Market Hypothesis (EMH) (Fama 1970
    Fama French 1992)
  • Modern Portfolio Theory by Markowitz (1952)
  • Super Effective Portfolio by Tobin (1958),
  • Capital Asset Pricing Model (CAPM) by Sharpe
  • Arbitrage Pricing Theory by Ross (1976).
  • A Paradox A modeling process based on
    prediction-free assumptions leads to predicting
    discrepancies of the market prices from the model

Quantitative Finance, Econophysics, and
  • Theory of Option Pricing by Black, Scholes and
    Merton (1970s), Long-term Capital Management
    Company, Option Pricing and Option Speculation
    are two different games.
  • Econophysics Fractal, Multi-fractal, Power Laws,
    Log-Periodicity, Criticality, Singularity, Mean
    Field Theory, Regularization Group, Minority
    Game, Minority-Majority Game, Herding, Financial
    Bubbles, Super-Geometrical Spiking, Trend
    Reversal, Financial Anti-Bubbles, Market Crashes,
    Threshold-based Decision Process, Jump Diffusion,
    Turbulence, Chaos, Intermittent Chaos.
  • Socionomics Robust Fractals, Elliott Waves,
    Spirals, Branches, Fibonacci Numbers, Social
    Mood, Fluctuation and Flow Patterns of Societal
    Activities, Historys Hidden Engine.

Schools of Thought in Quantitative Finance
  • Financial Mathematics Statistics
    Stochastic DE, volatility, option pricing, time
    series, GARCH
  • Econophysics Mandelbrot (1967, 1984, 1997,
    2004) Mantegna and Stanley 1999 Ilinski 2001
    Bouchaud and Potters 2003 Voit 2004 Sornette
    1996, 2003, 2005 Challet, Marsili Zhang
  • Behaviour Finance Shiller 2002
  • Computational Finance Farmer 2002 Farmer and
    Joshi 2002 Farmer et al 2003 LeBaron 2005
  • Long-term Prediction Campbell and Shiller
    1988 Sornette 1996-2006 Zhou and Sornette 2003
    Wang et al, 2003-2006
  • Short-term Prediction Lo and MacKinlay
    1988 Pan 2003-2006
  • Multilevel Process Analysis and Modelling Pan
    2003-2006 Kaufman 2005 Dacorogna et al 2001

Intelligent Finance An Introduction
  • Intelligent Finance represents an emerging
    comprehensive perspective to global financial
    markets unifying professional empirical wisdom
    and art of market analysis and academic research
    and science of market modeling.
  • Professional Schools include Fundamental,
    Technical and Strategic Analysis.
  • Academic Schools include Stochastic Process,
    Dynamical Systems, and Agent Models.
  • Intelligent Finance is a quest for a
    comprehensive approach, methodology and system of
    financial market analysis, investing and trading,
    aiming to generate absolute positive and
    nontrivial returns of investment by means of
    exploiting the complete information about the
    markets from all conceivable general
    perspectives, and simultaneously minimizing the
    very last risk incompleteness of a seemingly
    comprehensive investing or trading method or

  • The key tenet of Intelligent Finance
  • Every existing approach or methodology of
    market analysis, investing and trading should be
    considered a part of the total toolkit (arsenal)
    for profitable trading its effectiveness is
    time-varying relative to the state of the art of
    the total toolkit currently possessed by the
    investing public and to the current market mode
    and situation.

Absolute Positive Nontrivial Returns
  • Benchmark Levels of Intelligent Finance
  • RoIk (110)(k1) 1
  • RoI1 21 Qualification
  • RoI2 33 Buffett (24), Soros (32)
  • ……
  • RoI6-7 100 Day Traders
  • ……
  • RoI48-49 110 x 100 Robbins World Record
    Larry Williams,

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How is the world record 110 x 100 possible ?
Weekly Return (1 1)52 1.68
x 100 (1 2)52 2.80 x 100 (1
3)52 4.65 x 100 (1 4)52
7.69 x 100 (1 5)52 12.64 x 100
(1 6)52 20.70 x 100 (1 7)52
33.73 x 100 (1 8)52 54.71 x 100
(1 9)52 88.34 x 100 (1 10)52
142.04 x 100 The world record of futures
trading 110.00 x 100
A Trading System
The Pragmatic Objective of Intelligent Finance
  • can consistently generate positive and nontrivial
    returns of investment
  • with trivial draw-downs
  • at a sufficiently high degree of automation
  • operating in the global financial markets
  • (such as Medallion Fund and Santa Fe Institute)

Four Pillers of Intelligent Finance
  • Comprehensive exploit all the legally available
    information about the markets, economies and
  • Predictive exploit all the historical patterns
    from the existing data and current information to
    project the world into the future.
  • Dynamic assume the patterns are nonlinear and
    complex with both stochastic and dynamic natures
    and open to the future.
  • Strategic always be aware of the limitations of
    mathematical and computational modeling, react
    and act on the strategic intents of strategic

Topics of Research and Development
  • Historical Process Analysis
  • Current Situation Assessment
  • Effective Cycles and Seasonality Analysis
  • Future Price Tendency
  • Future Price Volatility
  • Macroeconomic Analysis
  • Microeconomic-Fundamental Analysis
  • Real-time Technical Analysis (Price, Volume,
    Money Flow, Mood)
  • Automated News Analysis (Politico-Economic-Financ
    ial Events)
  • Detecting Profitable Opportunities
  • Trade Planning (Entry, Stop Loss, Profit-Taking
    Exit, Positions)
  • Portfolio Construction and Management
  • Risk Analysis and Early Warning of Market
  • Financial Strategic Analysis (Maker Makers,
    Minority-Majority Game, Financial Warfare)
  • Global Stock Market Analysis
  • Global Currency Market Analysis (Forex)
  • Global Bond Market Analysis
  • Global Commodity Spot and Futures Market
  • Global Interest Rate Market Analysis

A Theoretical Framework of Intelligent
Finance (Pan, Sornette Kortanek, Quantitative
Finance, Vol. 6, No. 4, 2006)
  • Stylized Facts of Financial Market Structures and
  • Unified Assumptions underlying Financial Market
  • Financial Information Fusion from Fundamental,
    Technical, Strategic Analysis
  • Multilevel Stochastic Dynamic Process Modelling
    of Financial Prices
  • Active Porfolio Management and Total Risk Control
  • Financial Strategic Analysis and Intelligent
    Agent Modelling
  • Dynamic Optimization
  • Objective Prediction and Intelligent Trading
  • Macrowave Investing and Multifractal Trend

Three Major Research Directions of Intelligent
  • Financial Information Fusion
  • Multilevel Process Analysis
  • Dynamic Portfolio Management

2. Financial Information Fusion
  • Multiple Information Sources
  • Multiple Analysis Perspectives
  • Multiple Levels of Time Scale
  • Multiple Classes of Assets
  • Multiple Markets
  • Multiple Nations and Regions
  • Lead to
  • Many Profitable Opportunities
  • Many Sources of Risks
  • Too Many Things to Consider
  • Where Do We Start and End?
  • How Do We Streamline Information, Decision and

Multiple Perspectives of Financial Markets
  • Fundamental Analysis Value, Growth, Price, Margin
    of Safety, Market Shocks, Business Cycles,
    Industry Trends and Life Cycles, Competitive
    Advantage, Management Quality, Financial Health
    and Efficiency …
  • Technical Analysis Price, Index, Trend, Market
    Cycles, Price Waves, Swings Momentum, Support
    Resistance, Market Timing, Time Frames,
    Volatility Breakout, Stop Loss, Trendline Break,
    Trend Reversal …
  • Strategic Analysis Venture Capital, Public
    Listing, Liquidation, Market Makers,
    Accumulation, Lifting, Distribution, Dumping,
    Currencies-Stocks-Bonds, Takeover, Macrowave
    Investing, Conscious Reflexivity Process
    Investing, Market Catalysts, Shark School,
    Wolf Pack, Stop Running Game, …
  • Mental Analysis Survival of the Fittest, Your
    Personalized Trading System, Trade your System
    Carefree, Follow your System Religiously

The Pyramid of Financial Market Analysis
Strategic Analysis
Scale Gap
Mental Analysis
Psychological Gap
Technical Analysis
Marketplace Gap
Fundamental Analysis
All Master Investors are Complete Master
  • Warren Buffett is not only the world greatest
    Fundamental Analyst and Investor (value growth,
    long only), but also he had learned the
    essentials of Technical Analysis even before he
    started attending Benjamin Grahams class at his
  • George Soros has been the world greatest Trader
    with a mix of short and long strategies,
    profiting from testing conscious hypotheses on
    reflexivity processes on macroeconomic and
    international financial events, exhibiting FA,
    TA, SA.
  • Both Warren Buffett and George Soros share a same
    complete set of mental habits for consistently
    winning investment and grand-scale success.

Practical Exemplars of Intelligent Finance
  • Use Macro-Fundamental Analysis (global
    macroeconomical and financial macrowaves,
    business cycles, leading stock market cycles and
    sector rotations) to select international stock
    markets, bonds, currency pairs, commodities.
  • Use Micro-Fundamental Analysis (stock valuation,
    growth prospecting, competitive advantage,
    financial efficiency, management quality, …) to
    select stocks.
  • Use Macro-Technical Analysis (stock market index
    and sector indexes) for market timing and
    macro-portfolio planning.
  • Use Micro-Technical Analysis (daily charts,
    realtime intraday charts and live quotes) for
    trade timing.
  • Enter the Market using intraday charting and
    tactics with stop loss protection.
  • Hold the Position and Follow Trend in motion with
    trailing stop loss.
  • Exit the Market when either fundamental or
    technical criteria for profit taking or stop loss
    are met.
  • Manage General Portfolios (long and short)
    dynamically according to phase and strength of
    trends and risk management principles.

A Masterpiece by John Templeton, 2000-2001
Shorting NASDAQ with a trigger before the end
of lock-up period
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A true story about John Templeton, told by Mark
Tier 2004, 2006
  • Throughout 1999 until 13 March 2000, dot-com
    stocks zoomed to absurdly high levels.
  • Many value investors, realizing these stocks were
    wildly overvalued, shorted them all the way up.
  • This included some legendary money managers.
  • Having shorted even a bit too early before the
    peak could cause unlimited losses.
  • E.g. Julian Robertson eventually couldnt bear
    the pain any more and quit in disgust, shutting
    down his fund entirely. (Soros took some painful
    loss too).
  • However, John Templeton, at the tender age of 87,
    made a brilliant and enormously profitable foray
    back into the stockmarket.

  • Three months before the NASDAQ peaked, he
    discovered a trigger that allowed him to
    initiate one of the most creative short selling
    strategies ever devised.
  • The venture capitalists and insiders who floated
    these internet companies were typically
    restricted from selling their stock until six
    months or a year after the company had gone
  • Templetons insight was to use the end of this
    lock-up period as his trigger.
  • He systematically initiated short positions in 84
    different dot-com companies 11 days before the
    lock-up period for each stock expired.
  • 18 months later, hed added 86 million to his

  • During the Internet bubble and anti-bubble
  • Fundamental Investors missed
  • Technical Traders lost
  • But intelligent speculators made money -
    Integrate Fundamental, Technical and Strategic
    Analysis (like John Templeton)

A Framework of Financial Information Fusion
Strategic Intelligence
Market Maker Situation Intent
Stock Price Prediction
Stock Price Situation Analysis
Market Activity Events
Sector Situation Analysis
Politico-Economic Events
Strong vs Weak Stocks
Index Situation Analysis
Trading System
Market Price Data
Company Value Growth
Sector Index Prediction
Company Fundamentals
Industry Cycle Sector Rotation
Fiscal Policy
Interest Rate Yield Curve
Market Index Prediction
Macroeconomic Indexes
Growth Trend Business Cycle
An Empirical Model of Business Cycle, Stock
Market Cycle and Sector Rotation (ref Navarro,
2004 and macroeconomics textbooks)
Stock Market Sectors 1 Transportation 2
Technology 3 Capital Goods 4 Basic Industries
and Materials 5 Energy 6 Food, Drugs, Health
Care 7 Utilities 8 Financials 9 Autos,
Housing, Consumer Cyclicals
Business Cycle
Stock Market Cycle
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Economic Indicators Most Sensitive to US
Stocks (Bernard Baumhohl, 2006)
Economic Indicators Most Sensitive to US
Bonds (Bernard Baumhohl, 2006)
Economic Indicators Most Influential to US
(Bernard Baumhohl, 2006)
3. Multilevel Process Analysis of Financial
  • Why ? Heterogeneous Dynamic Market Hypothesis
  • How ? Multilevel Stochastic Dynamic Process
    (MSDP) Models of Financial Time Series

Facts and Assumptions underlying MSDP Models
(Dow 1880s, Graham 1930s Elliott 1930s,
Mandelbrot 1970-2004 Peters, 1991 Dacorogna et
al, 2001 Pan 2003-2006)
  • Heterogeneous Market Hypothesis Market
    participants are not homogeneous there are
    producers, hedgers, investors, traders and
    speculators different participants react to the
    same information in different ways with these
    characteristics - Different participants have
    different time horizons and dealing
    frequencies - Different participants are likely
    to settle for different prices and decide to
    execute their transactions in different
    situations, so they create volatility - The
    market is also heterogeneous in industrial and
    financial sectors and in the geographic
    location of the participants.
  • Fractal Market Hypothesis Different participants
    with different time horizons and dealing
    frequencies share the same human nature,
    consequently the market prices exhibit a fractal
  • Dynamic Market Hypothesis (Swingtum Market
    Hypothesis) The fractal market prices exhibit
    robust stochastic dynamic patterns in the scale
    space of time and price, which can be described
    in terms of multilevel trends, swings and

Multilevel Stochastic Dynamic Process (MSDP)
Models of Financial Time Series
  • Multilevel Chart Reading Unconscious
    Competence (MSDP - MCR)
  • Multilevel Fractal Decomposition - Top-Down
    (Fractal-Preserving Generalization) - Bottom-Up
    (Hilbert-Huang Transform) (MSDP MFD)
  • Multilevel Structural Time Series Models
  • Multilevel Stochastic Differential Equations
  • Multilevel Dynamic Process Patterns (Super
    Bayesian Influence Networks SBIN)
  • (MSDP - Models)

4. Dynamic Portfolio Management
  • Stationary Portfolio Theory
  • Arbitrage Pricing Theory
  • Dynamic Portfolio Theory
  • Factors and Models for Stock Returns
  • Factors and Models for Bond Returns
  • Factors and Models for Interest Rates
  • Factors and Models for Currency Exchange Rates
  • Factors and Models for Commodity Prices
  • Multilevel Phase Reconstruction and Market Timing
  • Multilevel Multiperiod Portfolio Theory
  • Multilevel Value at Risk Theory (general vs
    extreme conditions bubbles vs crashes)

A Trading System Must Be Personalized E.g. Pan
Swingtum Trading System
  • Human Intelligence
  • Swingtum Principles for Expert Trader
  • Swingtum Principles for Master Trader
  • Swingtum Trading Strategies
  • Swingtum Trading Time Windows
  • Swingtum Trading Signals
  • Computational Intelligence
  • Swingtum Prediction System
  • Swingtum Trading System

5. Conclusions
  • Finance has entered the era of Intelligent
    Finance out of a 100-years history of investing,
    trading, thinking and research.
  • Intelligent Finance provides a comprehensive
    approach to break through the Efficient Market
    Hypothesis to study the multilevel swing
    processes of market equilibrium.
  • Human being and the world are not chaotic, so
    there are invariant patterns, though maybe highly
    abstract and deeply hidden, in the market price
    behaviors, embedded in the economic dynamics.
  • Financial Information Fusion and Multilevel
    Process Analysis make it possible to break the
    symmetry between profit and loss on multiple time
  • Dynamic Portfolio Management provides a natural
    way to realize this possibility through a
    complete operational loop.
  • Intelligent Finance in general, are still at its
    early phases of research and development. Much
    remains to be done.

Pan Swingtum Principles
  • For Expert Trader
  • Survival of the Fittest
  • Enter Your Zone of Freedom
  • Avoid the Markets of Your Disadvantage
  • Be Practical
  • Be Empirical
  • Keep It Simple, Stupid! (KISS)
  • Trade Carefree
  • For Master Trader
  • Only Trade High-Probability Events
  • Invest First, Investigate Later
  • Exit First, Analyze Later
  • Concentrate with Minimal Diversification
  • Ride Reflexivity Process Consciously
  • Use Leverages, but Judiciously
  • Follow Your System Religiously

  • Read my motto
  • Before entering the market
  • Everyday

Pan Swingtum Daily Reading (Motto)
  • My God, show me the big way, give me the big
    morality and big wisdom
  • Follow the day trend first thing first, keep a
    distance. Dont be addicted to technicalities,
    remain natural, return to nature.
  • Every time when you trade, think as if you are
    standing on the verge of a cliff you strike back
    either to win or to die. Therefore, you must have
    infinite patience, but when you move, move
  • Remain tranquil and empty your desire. Do
    nothing most of the time, waiting for the right
    moment. Take no action until you see the trend
    emerge Enter with daylight.
  • Follow trend in motion with trailing stop loss.
    Make your decisions and take your
    responsibility. Survival of the fittest, not the
    smartest, not the coolest, not the prettiest.
    Leave your ego behind when entering the market.
    Always have your respect to the market, befriend
    with the market, dance with the market.

  • The End.
  • Thank you for your attention!