Forex Automaton

Note added on July 28, 2010: the quantitative results presented in this report have been found to be affected by a bug in the analysis code and are consequently incorrect. This report is kept here for the sake of historical completeness only.

This report continues our efforts to document the progress in the Day Range Strategy as the strategy is on its way towards production version. The research version of our system, known as Danica, has demonstrated in the six months of live operation that the high degree of predictability for daily extremes (low and high) is a reality, not a backtesting artefact. The Day Range Strategy is designed to benefit from the high stability of forecasts for daily extremes while minimizing the exposure to the forecast of daily close, by placing a protective stop and a profit target.

This third article in a series dedicated to patterns and stability of forex spread deals with EUR/JPY. As in other studies, the data come from a popular non-ECN broker. The only surprise here is the unexpected increse of the spread in 2009, both on absolute scale and in relation to the EUR/JPY quote.

Note added on July 28, 2010: the quantitative results presented in this report have been found to be affected by a bug in the analysis code and are consequently incorrect. This report is kept here for the sake of historical completeness only.

One of conclusions of the previous strategy research report was that one has to find a way to benefit from the high stability of quality forecasts for daily extremes (high and low) while minimizing the exposure to the forecast of daily close. One way to do that is trading with the profit target on the basis of forecasts for daily extreme levels (high and low) alone. This report begins a series dedicated to just such a strategy. The research will culminate in a launch of a new model trading system (this time with a trade signal and a simulated portfolio of some sort!) which will complement Danica.

This second article in a series dedicated to patterns and stability of forex spread deals with USD/JPY. In this pair, one of the most liquid in forex,  the spread is seen to be quantitatively very close to EUR/USD; its evolution during the day and week is also similar.

This article begins a series dedicated to forex spread (to be defined below as half the difference between bid and ask prices). In the series, a separate article will be dedicated to every forex pair we track. The issues of interest are evolution of spread in time, stability of spread during the day and week, and existence of predictable patterns in spread. Data from a popular non-ECN broker are used.

CHF/JPY resembles AUD/JPY in that its temporal distributions for high and low are heavily dominated by the early hours of the day (Central European time), reflecting morning activity in Japan.

For the first time, I address the question of how stable the optimization results are in time. While predictabilities of daily high and low show a highly stable pattern of dependence on the parameter subject to optimization, the positive results for close are mainly due to the high impact of a single period, which happens to cover the financial panic of the last quarter of 2008.

The main conclusion of the previous article was that a strategy with a position size distributed proportionally to the Kelly Criterion was found to be more attractive than the strategy were potential stop-loss would be distributed according to Kelly. A way to implement such a better strategy was understood to consist in fixing the stop-loss distance while having the position size proportional to Kelly allocation. For that, one would need to optimize the stop-loss distance. Here comes the promised development, improving the histogramming technique used to judge the "attractiveness" of a strategy, and elaborating on the choice of the stop-loss.

I compare four different position sizing strategies to use in algorithmic trading with Danica forecasting system. Two of them incorporate Kelly Criterion information. It seems that the strategy I have been using so far has been a sub-optimal one; a way to proceed is discussed.

AUD/JPY is the first entirely Asia-Pacific currency pair looked at with this approach so far. You can see the difference with other pairs, as the temporal distributions for high and low are heavily dominated by the early hours of the day (Central European time).

If you are following Danica trading system updates, you must have seen the table of Kelly capital allocations. These are estimates of the capital allocations to trades which, according to the theory of J.Kelly, maximize the speed of capital growth and are tuned to the historical success rate of the insight (forecasts in our case) on which the trading is based. According to Kelly, the rate of capital growth is maximized by having the allocation of capital to outcomes, given the forecast, match the probability distribution of those outcomes, given the forecast. The implementation of Kelly approach therefore is based on data base requests with specific selection conditions. Kelly allocations would, with enough data, converge to zero if darts throwing is used to make decisions. Same outcome would ensue if the real markets were replaced by hypothetic efficient markets of the academic finance. In this post I present and discuss a more complete version of the table, including negative allocations, some of which seem to apply consistently to a particular class of trades.

The pattern of daily lows and highs for USD/CHF is not too different from EUR/USD and GBP/USD. This study is added for the sake of completeness.

Currently there is little doubt that the next upgrade of our trading system will introduce some form of trade idea selection into the system's output. This article reports our recent progress towards implementing Kelly Criterion for capital allocation to trades. This is our first quantitative attempt to see what Kelly does to the expected profit per trade and the shape of its distribution.

USD/CAD is a purely North-American currency pair and it's interesting to compare its temporal patterns of activity with other forex pairs. American session dominates here. Temporal distributions of volatility are also available (see the one for USD/CAD here) can be used in a model context to reproduce these daily high and low distributions.

The Forex Automaton project was launched in April 2008 with the ambitious mission of leveraging certain algorithmic know-how to create a trading signal service useful to institutional and retail forex traders. This report highlights the noteworthy new developments that took place during the project's second year of life, from April 2009 through March 2010. The intent is to help the reader navigate what is becoming a rather complex network of research topics, concepts and results, by providing an overarching logical framework. Links to complete stories are provided.

I continue documenting the distributions of the moments of time daily high and low for the popular forex pairs are achieved. Some of the motivations for such type of analysis have been outlined in the first post on the topic. Availability of temporal distributions of volatility during a day (see the one for GBP/USD here) puts this type of study in a new context: significant deviation of shapes between the two distributions can be used to challenge a random walk model to reproduce the distribution of high and low on the basis of the volatility distribution.

I continue documenting the distributions of the moments of time daily high and low for the popular forex pairs are achieved. Some of the motivations for such type of analysis have been outlined in the first post on the topic. Appearance of temporal distributions of volatility (see the one for EUR/GBP here) puts this type of study in a new light, since significant deviation of shapes between the two distributions can be used to challenge a random walk model to reproduce the distribution of high and low on the basis of the volatility distribution.

So far, positive Pearson correlation coefficients between system forecasts and real forex moves on the day scale have been seen both during the back testing and in the live regime and it looks like a positive expectancy trading system has been indeed created. Among the methods of risk management, we have been focusing our effors on the issues of what forecasts to trade and how to allocate capital to trades. This report is our first research attempt to reduce risk by being selective about when to trade during the day.

I continue analyzing the timing of daily high and low for the popular foreign exchanges rates, one exchange rate at a time. Some of the motivations for such type of analysis have been outlined in the first post on the topic.

This is the second post in a series dedicated to analyzing the timing of daily high and low for the popular foreign exchanges rates. Some of the motivations for such type of analysis have been outlined in the first post on the topic.