Recently in FX Category
Article alludes to four areas of FX strategy, carry, fundamental discretionary, event driven, and mean reversion.
Talks about a multi-strategy approach to switch to be able to switch to the strategy that is performing well.
Keywords: technical trading rules, Markov switching, exchange rates, excess returns, predictability
This paper has used Markov switching models to create ex ante trading rules in the foreign exchange market. Markov models generate statistically and economically significant out-of-sample returns that are 95 basis points larger, on average, than those of conventional technical trading rules, and these returns appear to be fairly stable over time. The Markov rules provide at least two marginal benefits over conventional MA rules. An equally weighted portfolio rule of the Markov and MA rules provides a better risk-return trade-off than either alone. In addition, the Markov rules are strongly superior to the MA rules on the most recent data, in which the MA rules' profitability seems to have disappeared.
The Markov switching models deliver strong out-of-sample portfolio returns, although they fail to outpredict a naive, constant-return benchmark by MSE and MAE criteria. While the mean returns have diminished after 1991, tests reject structural breaks in Markov mean returns, which are still positive in every subsample, including the period from 2002 to 2005:6. Thus, Markov rule returns have been more stable than those of the conventional MA rules.
The ability of the Markov trading rules to identify trends in exchange rates might be linked to their use of information about higher moments. The fact that in-sample LR tests always preferred linking either the distribution's dispersion (scale of the variance) or kurtosis to the mean return supports this contention. Restricting the mean of the Markov model from using higher moments reduces overall mean annual out-of-sample returns by 1.5 percentage points and Sharpe ratios by 14 basis points. This suggests, but does not prove, that higher moments belong in the expectations of the Markov trading rule. The technical trading literature has not previously exploited higher moments in constructing rules.
The use of econometric methodology, rather than technical rules, to make trading decisions has at least two potential advantages. First, one can generate the entire multi-period distribution of exchange rate returns, enabling the risk-averse investor to better assess the risk-adjusted expected returns. A second potential advantage of an econometric methodology is that the stability of the model structure--rather than the return moments--can be assessed in real time, enabling traders to change their trading rules with the structure of the data-generating process. This paper did not explore those advantages.
Special FX: the asset class that thrives on volatility
"FX divisions are among the most profitable in the banks. Ultimately in 2008, FX was a significant contributor to profits," says Scott Wacker, managing director of foreign exchange sales at JPMorgan.
"Low volatility means a bear market for the foreign exchange industry and high volatility means a bull market," says Martin Wiedman, head of global forex sales at Credit Suisse.
"But if you still have a pulse, you are going to have the opportunity to make some serious money in FX over the next couple of years."
Full Story: 26b4d60c-f324-11dd-abe6-0000779fd2ac,dw.pdf
My Comments:
Intraday Volatility---Prices move more during certain parts of the global day.
In foreign exchange, currencies get traded more or less in the regions where they are used as currencies of account, ie. JPY in Japan, GBP in the UK, etc. USD is essentially the global currency used to measure value, with EUR becoming a closer second for this role.
FX Pairs move more when one of their currency's regions begin their day and, you get a distribution of volatility on pairs.
(Stole this from: http://i.investopedia.com/inv/articles/site/FX-3market2.gif)
Short & Long, 20pip stop / 40pip take. (meant to do 1 lot, but accidentally did 2 lots)
The market went almost straight down, $1080+, $540-, which is P/L $540+.
The risk is that the volatility drops off, and the market starts moving sideways again. Worse even, the market moves against you and you pay spread, and lose your ante'd stop loss.
Take a look at the last 3 weeks or so. Pay attention to the area under the Solid Blue (UK) boxes (and where they overlap with Solid Green boxes (US)). This is typically the most volatile time of the day. Since Lehman died, its a rare day that see daily range of less than a 100pips.
Depending on what the actual probabilities work out to be with whatever SL/TP I choose and the directionality from whatever point I initiate my trades turns out to be, the probability of working out might be less than 50% of the time. With only simple TP/SL, if the trade only works out 45% of the time, that means that the break even on the game is...
[Scenario 1 x Probability 1] + ... + [Scenario n x Probability n] = 0, (Break Even)
[(Win Scenario) x 45%] + [Losing Scenario x 55%] = 0,
[((Profit Took Side) + (Stopped Out Side) ) x 45%] + [2 x (Stopped Out Side) x 55%] = 0,
[(Take Profit - Spread) + (Stop Loss - Spread) ) x 45%] + [2 x (Stop Loss - Spread) x 55%) = 0,
[((91pips - 5pips) + (-20pips - 5pips)) x 45%] + [2 x (-20pips - 5 pips) x 55%] = 0
At 45% probability of win, 91pips is break-even,
At 50% probability of win, 80pips is break-even,
At 55% probability of win, 71pips is break-even.
Reducing loss, increasing win, and increasing winning probability are keys to any strategy.
When expecting a spurt of volatility, the fact that the trade has not won yet, indicates too little volatility for the strategy. A time-based narrowing of the exit range would probably be helpful at reducing loss. In this case, it would be good to start reducing losses by accepting a small loss on exit, which is better than waiting until the market starts moving against you and takes out the remenants of your trade.
Secondarily, there might be something to be said for a directional bias. A risk-neutral bias, based on close historical prices seems like it might be of some value. However, care needs to be taken to only make the strategy risk neutral, otherwise the strategy starts becoming a directional play, as opposed to a volatility play.
With that said, with a well timed entry where volatility typically picks up, a well devised trailing stop, and a loss reduction strategy, there might be a potential on an above average volatile day of 200-250pips, to return a maximum of 2 to 3x the break even distance of 80pips.
Since this strategy runs on volatility, another helpful ingredient might be having the program look back several days and measure the amount of volatility there was, and make it revise it's own strategy parameters to increase win probability. Even perhaps a simple implementation of a volatility model, GARCH, or something along those lines.
This leads me to thinking about a model that attempts to predict intraday volatility, and perhaps calculating win probabilities to size bets, maybe with the Kelly bet-sizing model, or a weakened form (as Kelly is known to be ultra aggresive.) Alas, I shall leave this for another day.
20081211 Bloomberg - Senate Rejects Auto Industry Bailout After Talks Fail.pdf
20081212 Reuters - US auto bailout crashes.pdf
20081212 NIKKEI NET - 大引け、５日ぶり大幅反落.pdf
The headline probably came out at about 22:30 EST --- And USD/JPY tanked 3.5%, bouncing back 1.5%.
and the Nikke 225 started tanking right out the the gate at 12:30 JST...
to drop 6% and bounce back 2.5%...
Not that there is any doubt that news moves prices, but its interesting to confirm it once in a while.
However, thats the way the markets have been moving anyhow, so it seems to be yet just another confirmation of the current trend.
Cheers.
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