Forex trading system: are we there yet?

A series of articles on the automated forex trading system development.

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ForexAutomaton 2013. The Fifth Annual Summary of Researh Progress
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Written by Forex Automaton   
Sunday, 14 April 2013 16:53

Success of algorithmic trading has as much to do with the market as with the nature of the algorithm. While the algorithms may vary and may have terms such as artificial intelligence, adaptivity, machine learning, neural networks and the like associated with them, the phenomenology of what it is that the machines are "learning" all comes down to correlation measurements of varying order -- pairs, triplets, quadruplets... -- over a variety of time lags and time scales, performed on the market time series.

ForexAutomaton began its life on April 02, 2008, five years ago. Year V was exceptionally productive for the project. Here are the main highlights of this annual review:

  • An Index of Correlation Strength (CERCSI) and a Predictability Index have been formulated and the history of these measures has been established.
  • Index of Correlation Strength reveals that a regime switch in the market dynamics took place in Summer 2007.
  • Danica, the daily forecast system, has confirmed its status of an "Anti-System", delivering its forecasts in the non-random and consistent opposition to the market reality.
  • The challenge of regime switch has been addressed by implementing an algorithm, nicknamed Twisted Pair, to incorporate sensitivity to two basic types of memory effects: trending and reversion to the mean.
  • Danica, the daily forecast system, and Heidi, the hourly system, have been upgraded with the Twisted Pair algorithm.
Last Updated on Friday, 12 June 2015 15:51
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Heidi performance review, ten months since the parameter change
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Written by Forex Automaton   
Saturday, 01 December 2012 14:43

Heidi is the hour time-frame trading system generating predictions of hourly high, low and close for the 14 popular currency pairs. This post reviews the summary performance metric of the system, the correlation coefficient between the predicted and actual hourly logarithmic returns. Results are presented graphically.

Last Updated on Wednesday, 10 April 2013 17:21
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Forex Automaton Black Box response to mean-reversion and trending
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Written by Forex Automaton   
Sunday, 28 October 2012 12:09

 Three types of input time series (open, close, high, low) have been simulated: one based on independent returns, a trending one, and one with an oscillating autocorrelation (with an effect dubbed "mean reversion" incorporated). The current version of the Forex Automaton Black Box algorithm with same parameters has been applied to each time series in the usual fashion, where after initial learning time, forecasts are generated for the coming bar using only past information, for the rest of the time series. 

The Monte Carlo study of the trending sample produces Black Box forecasts resulting in positive correlation coefficients between predicted and real returns for daily maxima, minima, and close.

 The Monte Carlo study of the oscillating autocorrelation ("mean reversion") sample reproduces the features of real-life (Danica) Black Box performance when applied to the daily FX bars aggregated with an opening at 9am US Eastern time, namely, positive correlation coefficients between predicted and real returns for daily maxima and minima in combination with negative correlation coefficients between predicted and real returns for daily close.

Last Updated on Saturday, 01 December 2012 14:47
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ForexAutomaton 2012. The Fourth Annual Summary of Research Progress.
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Written by Forex Automaton   
Sunday, 08 April 2012 15:00

Four years of ForexAutomaton's life are over. This year I have been busy starting a currency risk consulting company, along with two partners, therefore less than the usual amount of research content has been published here. Nonetheless, the automated systems -- Danica, Demi, and Heidi -- have been living their silicon-based lives as before, with little to no interference from their creator. This fourth annual report is dedicated entirely to news from their side.

Last Updated on Sunday, 14 April 2013 16:59
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Demi performance review, June 2011
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Written by Forex Automaton   
Sunday, 05 June 2011 15:24

This post begins monthly peformance reviews for the Demi line of EUR/USD daily time frame trading systems. There are four systems in total, differing only according to the choice of the closing hour of the "day": 3, 5, 9 and 11 am Eastern time. The systems went live on August 25, 2010, after extensive back-testing. Since then, the parameters found in the course of the back-testing have been frozen. Even though the system output (see Demi section of the site) is available only to the registered members, the performance reviews will be available publicly.

Last Updated on Saturday, 25 August 2012 14:18
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ForexAutomaton 2011. The Third Annual Summary of Research Progress.
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Written by Forex Automaton   
Monday, 04 April 2011 07:36

The third year of ForexAutomaton's life has come to a closure. As usual, presented here is the summary of main problems that occupied me during the year, and the main achievements. For the first time, the annual report includes reviews of the actual trading and forecasting systems which have been running live on this web site since the beginning of 2010, free and accessible to the public. The report is structured around system performance and development while observational studies of market inefficiency take a back seat. The prediction engine remains a Black Box to the reader.

Executive Summary.
  • Statistical predictability of the direction in which each of the extremes of the price-chart bar evolves is proved to be insufficient to  claim market inefficiency, and is understood to have mundane roots in the diffusion of price under conditions of limited price continuity,  as is borne out by the random walk model.

  • Differences between hypothetically efficient and real FX markets manifest themselves in higher order correlations, namely fourth order cumulants among certain real data and their proprietary forecasts.

  • A strategy attempting to take advantage of these properties of the real FX markets, Demi, has been designed and launched. Results of the first seven months of its live paper trading are reviewed.

  • A system making predictions on the hourly time frame, named Heidi, has been launched.

  • Following a detailed analysis of the intra-day seasonality patterns such as the alternation of trend following and mean-reversion, Heidi has been improved for at least some of the intra-day time periods by making it seasonality-cognizant.

  • The oldest system, Danica, generating predictions on the day scale, has so far been unable to provide systematic positive correlations between its forecasts for the direction of daily close and the actual direction in live operation, but the cause seems to go beyond the choice of the adjustable parameter.

Last Updated on Sunday, 08 April 2012 15:03
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Incorporating seasonality into Heidi. A concept of a better forecasting component for an intraday trading system.
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Written by Forex Automaton   
Monday, 07 March 2011 17:21

Hourly time scale in forex provides roughly 24 times more statistics, than the daily scale. Therefore, if a single adjustable parameter for all currency pairs is justifiable in the daily system optimization (Danica), 24 parameters can be adjusted for Heidi without jeopardizing significance of the results. The natural way of increasing the number of parameters is to split the 24-hour day into time window "seasons" and treat the seasons as independent pattern recognition problems in the code and as independent optimization problems on the stage of optimization.

Last Updated on Saturday, 07 July 2012 10:44
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Intraday seasonality as a source of alpha
Written by Forex Automaton   
Friday, 28 January 2011 12:20

The effect discussed in this post became visible after analyzing intra-day hour-scale data for the six major currencies and synthesizing the findings. Much of the discussion and effort documented on this site is related to adaptive forecasting algorithms with the view that the direction of price would be conditioned somehow by the past direction in the same or different markets. In contrast, the effect I am about to describe amounts to the direction of price movement being dependent not so much on the history, but on the point in time (wall clock reading). To verify stability of the effect, I compare intermarket averages over several years and temporal averages over the six popular currency markets (AUD, GBP, EUR, CAD, CHF, JPY).

Last Updated on Tuesday, 08 March 2011 14:34
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Even in the random walk, locations of daily high and low are non-uniformly distributed in time
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Written by Forex Automaton   
Friday, 14 January 2011 12:44

I have been looking at the temporal distributions of daily highs and lows in forex for quite some time now (see the EUR/USD report, the first one on the subject). Later I began complementing the data with a similar distribution of variance and 1-hour lag autocorrelation (here is the distribution for EUR/USD), trying to infer whether there is a systematic change in correlation regime from trend following to mean reversion during the day. The inference would be based on combining second order statistics and daily extreme distribution data. It had been tacitly assumed that random walk would have a featureless temporal distribution of daily extremes. In this post I document the "base-line" shape of this distribution: due to peculiar memory effects found even in the random walk (continuity of price), the shape of such distributions has certain characteristic features.

Last Updated on Wednesday, 23 February 2011 16:18
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Fourth order cumulant study with more FX rates and time windows
Written by Forex Automaton   
Wednesday, 13 October 2010 14:13

The previous study revealed the positiveness of the fourth-order cumulant among the logarithmic increments for 24-hour highs and lows in EUR/USD and the respective ForexAutomaton forecasts. By expanding the scope of the study to include all of the 14 most popular exchange rates, and by splitting the time span of the simulated trading into five independent intervals, I demonstrate that the result is not just a feature of EUR/USD and is stable in time. The data hint at a correlation between the fourth-order cumulant under study and predictability of close (measured by Pearson correlation coefficient between predicted and actual logarithmic returns). However, the signal strength for these figures of merit, defined as the ratio of the value in question to the estimated precision of its measurement, appears to lend more credibility to the cumulant.

Last Updated on Saturday, 24 March 2012 11:18
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Fourth order cumulant in EUR/USD falsifies random walk hypothesis
Written by Forex Automaton   
Wednesday, 15 September 2010 16:14

Ability to predict the up-coming changes in daily and hourly high and low of price (of course, in a statistical sense, as measured by correlation coefficients between prediction and reality) by using adaptive black-box models has been well documented on this site. Observation of statistical dependence of the extreme levels of price (high and low) within a time bin on the immediate past of the time series, reported for the random walk model, explains and, particularly in the context of searching for market inefficiencies, even trivializes this achievement. Indeed, market inefficiencies are not required for the diffusion equation (cf. Black-Scholes theory) to work. Are we merely creating black-box equivalents of the popular tools of financial engineering? Enter higher-order cumulants. Shown here are measurements of the fourth order cumulants among the 24-hour high and low and the respective forecasts in real-life EUR/USD data; these can now be compared with the values they had in the random walk data. The difference revealed is dramatic.

Last Updated on Saturday, 10 March 2012 15:44
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Markov property of the extremes in the binned random walk time series
Written by Forex Automaton   
Wednesday, 08 September 2010 16:00

Random walk is an important reference process in statistics and its properties have to be studied in financial applications, where hypothetic random walk of price remains an essential component of efficient market theories. Our day and hour time-scale predictive models demonstrated stable positive correlations between reality and prediction for returns taken in the time series of the respective (daily and hourly) lows and highs. However, same property is shown to hold for the simple Brownian motion random walk model. What are the origins and the implications of this effect?

Last Updated on Tuesday, 22 March 2011 09:45
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Temporal distribution of GBP/JPY low and high during a day
Written by Forex Automaton   
Wednesday, 04 August 2010 13:27

GBP/JPY, CHF/JPY and AUD/JPY seem to fall in the same group as far as the temporal distributions for high and low are concerned. The most likely time for the day's high and low to be made in these currency pairs is the early hours of the day (Central European time), reflecting morning activity in Japan.

Last Updated on Thursday, 17 March 2011 16:58
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Revisiting the Day Range Strategy. Part 2.
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Written by Forex Automaton   
Tuesday, 06 July 2010 15:02

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.

Last Updated on Tuesday, 17 August 2010 14:36
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Temporal patterns and history of EUR/JPY spread, 2003-2009
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Written by Forex Automaton   
Wednesday, 23 June 2010 13:39

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.

Last Updated on Friday, 29 October 2010 11:47
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Revisiting the Day Range Strategy. Part 1.
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Written by Forex Automaton   
Wednesday, 16 June 2010 15:52

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.

Last Updated on Tuesday, 17 August 2010 14:36
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USD/JPY spread patterns and history, 2003-2009
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Written by Forex Automaton   
Monday, 14 June 2010 16:06

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.

Last Updated on Wednesday, 23 June 2010 13:42
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EUR/USD spread patterns and history, 2003-2009
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Written by Forex Automaton   
Tuesday, 08 June 2010 11:52

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.

Last Updated on Monday, 14 June 2010 16:10
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Temporal distribution of CHF/JPY low and high during a day
Written by Forex Automaton   
Monday, 31 May 2010 08:26

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.

Last Updated on Friday, 14 January 2011 13:31
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Temporal (in)stability of trading system optimization curves
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Written by Forex Automaton   
Friday, 21 May 2010 09:52

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.

Last Updated on Saturday, 21 January 2012 16:55
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Kelly position sizing with a fixed stop-loss; dangers of tight stop-loss
Written by Forex Automaton   
Thursday, 13 May 2010 15:44

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.

Last Updated on Tuesday, 07 December 2010 14:46
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