Stocks & Commodities V. 34:07 (22–25): Shannon Entropy Indicator by Stephen Massel

Shannon Entropy Indicator by Stephen Massel

Here’s an indicator that discerns the nature of the underlying market and helps you decide whether you should trade trends or channels.

In my last article on Shannon entropy in the August 2015 issue of STOCKS & COMMODITIES, I introduced the concept of using entropy to detect structure, or nonrandomness, in a strategy’s trading results. In this article, I will extend this idea and create an indicator that seeks to discern the nature of the underlying market and whether price action is acting randomly or with more purpose. This can then be used to help decide whether to be trend trading or channel trading.

But first, a few words on entropy. As well as providing a measure of structure/randomness in data, entropy can be considered a measure of dispersion; the more mixed up or evenly distributed the data, the higher the entropy, as in a pack of well-shuffled playing cards...