Stock trading rule discovery with an evolutionary trend following model

• eTrend is a hybrid long-term and short-term evolutionary trend following model.
• eTrend generates high Sortino ratio and cumulative return after transaction cost.
• eTrend outperforms B&H strategy, as well as DT and ANN trading models.
• Concept drift analysis has identified adverse rules between bear and bull markets.

Evolutionary learning is one of the most popular techniques for designing quantitative investment (QI) products. Trend following (TF) strategies, owing to their briefness and efficiency, are widely accepted by investors. Surprisingly, to the best of our knowledge, no related research has investigated TF investment strategies within an evolutionary learning model. This paper proposes a hybrid long-term and short-term evolutionary trend following algorithm (eTrend) that combines TF investment strategies with the eXtended Classifier Systems (XCS). The proposed eTrend algorithm has two advantages: (1) the combination of stock investment strategies (i.e., TF) and evolutionary learning (i.e., XCS) can significantly improve computation effectiveness and model practicability, and (2) XCS can automatically adapt to market directions and uncover reasonable and understandable trading rules for further analysis, which can help avoid the irrational trading behaviors of common investors. To evaluate eTrend, experiments are carried out using the daily trading data stream of three famous indexes in the Shanghai Stock Exchange. Experimental results indicate that eTrend outperforms the buy-and-hold strategy with high Sortino ratio after the transaction cost. Its performance is also superior to the decision tree and artificial neural network trading models. Furthermore, as the concept drift phenomenon is common in the stock market, an exploratory concept drift analysis is conducted on the trading rules discovered in bear and bull market phases. The analysis revealed interesting and rational results. In conclusion, this paper presents convincing evidence that the proposed hybrid trend following model can indeed generate effective trading guidance for investors.