The First Annual Summary of Forex Automaton Research Progress, April 2009 - Leading indicators

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Written by Forex Automaton   
Friday, 03 April 2009 13:22
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The First Annual Summary of Forex Automaton Research Progress, April 2009
Forex bipolarity
Leading indicators
Periodicity or oscillation
What did the crisis change?
Black-box algorithm paper-trading
Conclusions. Future.
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Pattern 2: "leading indicators"

Correlated patterns can involve more than one market or forex exchange rate. A cross-correlation or intemarket correlation, fully analogous to the autocorrelation, is the way of detecting such patterns. Unlike an autocorrelation, the inter-market correlation does not need to be symmetric, and its lack of symmetry, if significant, indicates that the forex exchange rates are not born equal: there are leaders and followers among them.

Like the autocorrelation, cross-market correlation is a function of its time lag variable

td = t1 - t2,

where indices 1 and 2 denote different market time series. A large positive correlation at lag td=0 indicates that the markets move in tandem, a large negative one -- that they move in the opposite directions. Non-zero correlations at non-zero time lags are particularly informative, it is these correlations that allow us to make statements like "A leads and B follows". Indeed, if A leads and B follows, then the movement that happened in A at t1 = a, happens in B at time t2 = a+d, where d is greater than 0. Then, a positive correlation value is associated with

td = t1 - t2 = a - (a+d) = -d.

Naturally, an even larger positive correlation value is likely to be associated with lag 0, but the peak will look skewed to the left. Similarly, one can discuss a situation when B leads and A follows, the two being positively correlated, and conclude that the correlation peak will be skewed to the right.

AUD/JPY leading indicator for EUR/CHF AUD/JPY leading indicator for EUR/USD AUD/JPY leading indicator for GBP/USD CHF/JPY leading indicator for EUR/AUD CHF/JPY leading indicator for CHF/USD
EUR/JPY leading indicator for EUR/AUD EUR/USD leading indicator for CHF/EUR GBP/USD leading indicator for CHF/EUR EUR/JPY leading indicator for EUR/USD EUR/JPY leading indicator for GBP/USD
EUR/JPY leading indicator for CHF/USD GBP/JPY leading indicator for EUR/USD EUR/USD leading indicator for JPY/USD GBP/USD leading indicator for CAD/USD EUR/CHF leading indicator for USD/JPY

Fig.2.1.Pairs of exchange rates with the most stunning predictive cross-correlations on the hour scale. Click on the panel to get to the article reporting the measurement. Top row, left to right: AUD/JPY and EUR/CHF, AUD/JPY and EUR/USD, AUD/JPY and GBP/USD, CHF/JPY and EUR/AUD, CHF/JPY and USD/CHF. Middle row, left to right: EUR/AUD and EUR/JPY, EUR/CHF and EUR/USD, EUR/CHF and GBP/USD, EUR/JPY and EUR/USD, EUR/GBP and GBP/USD. Bottom row, left to right: EUR/JPY and USD/CHF, EUR/USD and GBP/JPY, EUR/USD and USD/JPY, GBP/USD and USD/CAD, USD/JPY and EUR/CHF. Vertical scales may differ among panels.

The good news is that the leading indicators are detectable with this method of analysis, and some of them are seen with a very high degree of statistical significance. The bad news is that the question "Which is the leading indicator for A?" has no straightforward general answer. It is not clear what makes B a leading indicator for A and not for C, or why D has no leading indicator. As a very crude rule of thumb, it can be inferred that a forex rate with a high interest rate differential, like AUD/JPY or EUR/JPY is likely to serve as a leading indicator for other exchange rates.



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