Automated trading using deep learning and machine learning, trading strategy using K-Nearest Neighbors (KNN) to make trading decisions based on similar past data.

Automated Trading Using Deep Learning and Machine Learning: Trading Strategy Utilizing K-Nearest Neighbors (KNN)

Today, automated trading systems in financial markets play a significant role in learning complex market patterns using technologies such as data science, deep learning, and machine learning to make trading decisions based on this knowledge. Especially in cryptocurrency markets such as Bitcoin, where volatility is high and sudden price changes are common, these technologies are even more crucial. In this course, we will explore how to design a Bitcoin trading strategy by analyzing similar past data using the K-Nearest Neighbors (KNN) algorithm.

1. Overview of K-Nearest Neighbors (KNN) Algorithm

KNN is one of the unsupervised learning techniques in machine learning, used to find similar data based on given data and make predictions. The core idea of KNN is that when a new data point is given, it identifies the K closest neighbor data points and determines the result based on the majority class among them. While KNN is mainly used for classification problems, it can also be applied to regression problems.

2. Principles of KNN

The KNN algorithm operates in the following steps:

1. Calculate the distance between all points in the dataset.
2. Select the K nearest neighbors to the given point.
3. Return the most frequently occurring class or average value for prediction.

A significant advantage of KNN is its simplicity in implementation and ease of understanding. However, a drawback is that as the amount of data increases, the computational cost rises, and it is sensitive to the curse of dimensionality.

3. Designing an Automated Trading System

To design a Bitcoin automated trading system, the following steps should be taken:

1. Data Collection: Collect historical price data of Bitcoin.
2. Data Preprocessing: Organize the collected data and convert it into a format suitable for the KNN model.
3. Model Training: Use the KNN algorithm to train the model based on past data.
4. Establish Trading Strategy: Design an algorithm to make trading decisions based on the predicted results.

4. Data Collection

Various data provider APIs can be used to collect Bitcoin price data. Here, we will introduce how to fetch data from the CoinGecko API using Python. The code below is an example of collecting daily price data for Bitcoin:

import requests
import pandas as pd
from datetime import datetime

# API Call
url = 'https://api.coingecko.com/api/v3/coins/bitcoin/market_chart'
params = {
    'vs_currency': 'usd',
    'days': '30',  # Last 30 days of data
    'interval': 'daily'
}
response = requests.get(url, params=params)
data = response.json()

# Create DataFrame
prices = data['prices']
df = pd.DataFrame(prices, columns=['timestamp', 'price'])

# Convert Timestamp
df['timestamp'] = pd.to_datetime(df['timestamp'], unit='ms')

# Display Data
print(df.head())

5. Data Preprocessing

The collected data must be transformed into a suitable format for the model by removing outliers, handling missing values, and performing feature engineering. For example, technical indicators can be added based on price data. Commonly used technical indicators include Moving Average (MA), Relative Strength Index (RSI), and MACD. The code below is an example of adding a moving average:

# Adding Moving Averages
df['MA_10'] = df['price'].rolling(window=10).mean()
df['MA_50'] = df['price'].rolling(window=50).mean()
df.dropna(inplace=True)

6. Training the KNN Model

Once the data is prepared, the KNN model can be trained. The sklearn library can be used for this purpose, and the K value can be optimized through experimentation. Below is the code for training the KNN model and making predictions:

from sklearn.model_selection import train_test_split
from sklearn.neighbors import KNeighborsClassifier
from sklearn.metrics import classification_report

# Separating Features and Labels
X = df[['MA_10', 'MA_50']].values
y = (df['price'].shift(-1) > df['price']).astype(int)  # If the next day's price increases, 1; if decreases, 0

# Split into Training and Test Sets
X_train, X_test, y_train, y_test = train_test_split(X, y, test_size=0.2, random_state=42)

# Train KNN Model
knn = KNeighborsClassifier(n_neighbors=5)
knn.fit(X_train, y_train)

# Prediction and Evaluation
y_pred = knn.predict(X_test)
print(classification_report(y_test, y_pred))

7. Implementing Trading Strategy

An algorithm can be implemented to make trading decisions based on the model’s prediction results. For example, if the model predicts that the price of Bitcoin will rise, a buy order can be placed, and if it predicts that it will fall, a sell order can be executed:

def trading_signal(prediction):
    if prediction == 1:
        return 'Buy'  # Predicted to rise
    else:
        return 'Sell'  # Predicted to fall

# Generate Signal for Last Data
last_prediction = knn.predict(X[-1].reshape(1, -1))
signal = trading_signal(last_prediction[0])
print(f"Trading Signal: {signal}")

8. Performance Evaluation

The performance of the trading strategy can be evaluated through various metrics. Return, Sharpe ratio, and maximum drawdown can be considered, and the effectiveness of the strategy can be validated through experimental backtesting methods. The following code example simulates trading results based on past data:

initial_balance = 1000  # Initial Investment
balance = initial_balance

for i in range(len(X_test)):
    if y_pred[i] == 1:  # Buy
        balance *= (1 + (df['price'].iloc[i+len(X_train)] - df['price'].iloc[i+len(X_train)-1]) / df['price'].iloc[i+len(X_train)-1])
    else:  # Sell
        balance *= (1 - (df['price'].iloc[i+len(X_train)] - df['price'].iloc[i+len(X_train)-1]) / df['price'].iloc[i+len(X_train)-1])

final_balance = balance
profit = final_balance - initial_balance
print(f"Initial Balance: {initial_balance}, Final Balance: {final_balance}, Profit: {profit}")

9. Conclusion

KNN is a simple yet effective machine learning algorithm, which can be a useful tool for establishing automated trading strategies for Bitcoin. In this course, we have learned how to build an automated trading system and establish trading strategies using KNN. However, since KNN may have limitations by itself, it is recommended to develop more sophisticated strategies by combining it with other algorithms or using ensemble techniques. Continuously validating and adjusting existing trading strategies is also important.

If you seek more information and strategies on Bitcoin automated trading, please refer to related literature and research materials to expand your in-depth knowledge.