An Intrinsic Entropy Model for Exchange-Traded Securities

TL;DR

This paper presents an intrinsic entropy model based on actual trading data to gauge investor interest and market trends for exchange-traded securities, aiding intraday trading decisions.

Contribution

The paper introduces a novel intrinsic entropy model that uses only trading data, without external factors, to predict market inclination and support algorithmic trading strategies.

Findings

The model effectively signals buy or sell tendencies.

Empirical tests on BVB data validate the model's predictive capability.

The model assists in intraday stock portfolio selection.

Abstract

This article introduces an intrinsic entropy model that can be used as an indicator to gauge investor interest in a given exchange-traded security, along with the state of the general market corroborated by individual security trade data. Although the syntagma of intrinsic entropy might sound somehow pleonastic, since entropy itself characterizes the fundamentals of a system, we would like to make a clear distinction between entropy models based on the values that a random variable may take and the model that we propose, which employs actual stock exchange trading data. The model we propose for intrinsic entropy does not include any exogenous factor that could influence the level of entropy. The intrinsic entropy signals whether the market is inclined to buy the security or rather to sell it. We further explore the usage of the intrinsic entropy model for algorithmic trading, in order to demonstrate the value of our model in assisting investors in the selection of the intraday stock portfolio, along with timely generated signals to support the buy / sell decision making process. The test results provide empirical evidence that the proposed intrinsic entropy model can be used as an indicator to evaluate the direction and intensity of intraday trading activity of an exchange-traded security. The data used for the test consisted of historical intraday transactions executed on The Bucharest Stock Exchange (BVB).