CHF/JPY 2002-2008: predictability overview

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Written by Forex Automaton   
Thursday, 15 May 2008 11:16

The Swiss Franc / Japanese Yen in 2002-2008 has been showing a "contrarian" trend reversal tendency in addition to the trend repetition signal with a 24-hour-multiple time lag seen in most other currency pairs.

In this report we focus on the period from 00:00 2002-08-20 to 00:00 2008-02-01 (New York time). This is a pair of low yield currencies. The Bank of Japan held its discount rate at historic minima (hitting 0.1% in September 2001). Swiss National Bank's three-month Libor rate target hit historic minimum in 2003-2004. On average for the period, the Swiss Franc enjoyed a higher yield.

CHF/JPY autocorrelation 1 hour time-lag bin

Fig.1:Autocorrelation of hourly logarithmic returns in CHF/JPY. The time lag is in "business time" (periods without update ticks are excluded). The red band shows the level of noise as iferred from martingale simulations (see text).

The basic autocorrelation

As before we employ autocorrelation as a straightforward, inter-disciplinary, non-proprietary technique to test market efficiency. In Fig.1 we look for features on the time scale of up to two days such as to suit the time scale of day trading or swing trading. The hatched red band shows the range of statistical noise (namely its expectation plus minus its RMS deviation). Statistical noise was obtained by simulating 20 independent time series of the length corresponding to that of the CHF/JPY series, each one constructed to reproduce the measured distribution of returns for CHF/JPY for the time period under study (including the fat tails!), but completely devoid of correlations ( martingale time series ). From these, the expectation and RMS or the autocorrelation amplitude in each time lag bin were calculated. The one-hour time lag "contrarian" feature (a significant anticorrelation) we saw on this plot in other currency pairs involving JPY ( GBP/JPY and AUD/JPY ) is also present in the CHF/JPY autocorrelation. The autocorrelation being an average of a product of hourly returns taken with a lag, this negativity means that we are way too frequently taking a product of opposite sign returns -- or that the product of the opposite sign returns far outweighs that of the same sign returns. Because trend reversals on the time scale of about one hour happen either too often or are too lucrative, CHF/JPY, like GBP/JPY and AUD/JPY analyzed before, may well be the market where winning strategy requires being a clever contrarian. We increase the time lag bin to four hours in Fig. 2 to try and see if we can locate a trigger signal -- something that could alert you to take a contrarian position with more confidence.

CHF/JPY autocorrelation 4 hour time-lag bin

Fig.2: CHF/JPY autocorrelation as in Fig.1, but with time lag bin increased to 4 hours.

In Fig.2, the time lag bin has been increased to 4 hours. This figure does not reveal any new reliable patterns, although one might argue there is a hint of a zigzag pattern with a period of about 2 weeks.

24-hour trading cycle.

 

CHF/JPY bullish and bearish autocorrelation

Fig.3: CHF/JPY bullish and bearish autocorrelations. Yellow: correlating only positive hourly returns. Blue: correlating only negative hourly returns.

In Fig.3 we construct autocorrelations of the subsamples of the full time series (the "bullish" and "bearish" ones) selected by taking only positive and negative returns respectively. The 24 hour cycle of bullish and bearish action is again clearly seen as the maxima of the correlation are located at multiples of the 24 hour lag: 24, 48, 72, 96, 120 hours and so on. Therefore, smart trend following means something more than following a trend that existed in the near past. It means following a trend that existed this time of the day yesterday, the day before yesterday, and so on -- that gives you better than average chance of winning! Conversely, buying because the currency went up 12 hours ago (or selling because it went down 12 hours ago), all the rest being equal, is the least recommended strategy. (See why this cyclic correlation feature is not in itself a prediction mechanism.) Needless to say, this effect is not present in the simulated martingale data.

Note that whether this trend following pattern is equally strong in all time zones (at all times during the day) is a question that requires a separate study.

CHF/JPY bullish and bearish autocorrelation long range

Fig.4: CHF/JPY bullish and bearish autocorrelations. Axes and color codes as in the previous figure. Range expanded compared to the previous figure to show the characteristic time length of this market memory effect.

Similar patterns have been seen before with most other currency pairs in this series of predictability reviews. It is interesting to note that typically, such correlation has higher amplitude when "bearish" refers to the currency with higher interest rate. This has been seen with AUD/USD , AUD/JPY, USD/JPY, GBP/JPY, USD/CAD (although the interest rate differential has not been that high, it is in favor of USD), AUD/USD. While in the case of classic carry-trade currency pairs such as AUD/JPY this has been associated with the unwinding of the carry-trade, the underlying mechanism is likely to be similar for other currency pairs. The fact that one can read the sign of interest rate differential off the public forex quotes via basic correlation analysis is -- should this interpretation prove correct -- astonishing and indicates that despite large liquidity such interest rate differentials are not completely discounted by the markets and there remain profit opportunities for algorithmic trading.

Summary

As most other currency pairs analyzed, CHF/JPY is not completely "efficient" from the point of view of basic two-point correlation analysis. Long term prospects of CHF/JPY are the subject of fundamental analysis and are outside the scope of this article. Cross-correlations with other markets are to be discussed in the up-coming articles.

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