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A brief (10 minute) presentation on my thesis "Profitability of automated technical trading strategies in the foreign exchange market". Presented as part of the CSULB student research competition on ...

A brief (10 minute) presentation on my thesis "Profitability of automated technical trading strategies in the foreign exchange market". Presented as part of the CSULB student research competition on 2/25/11

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  • Pairs – cannot only buy USD. You must buy USD and also sell another currency like JPY
  • Prior = 5 years prior to the 2001 studyTA expanded from 19% (least of the 4) to 30% (greatest of the 4)
  • Optimizing on ½ of the data is done to prevent “curve fitting” or data snooping biasThe most time consuming part of the processOptimizations take between 1 hour to multiple daysTook over 6 months with 5 computers working simultaneously 24/7
  • 27 out of 63 have positive sharpe ratios (43%)Comparable to 7 out of 23 (30%) in Likac and Brorsen (1990)
  • 3 of 7 currency pairs have excess return relative to risk (43%)Interesting that GBPJPY is the only unprofitable one. It is regarded as the most volatile and therefore should have most trading opportunitiesHigher transaction costs may be a factor
  • Channels and bands performed the bestMean reversion – RSI and Stochastic performed worst

Src presentation technical trading systems in forex Presentation Transcript

  • 1. Brian Leip
    Profitability of automated technical trading systems in the foreign exchange market
    College of Business Administration
    Finance Major, CBA Honors Program
    Supervisor: Dr. Pamela Miles Homer
  • 2. OUTLINE
    Purpose of the Study
    Introduction
    Background and Literature Review
    Methodology
    Hypotheses
    Results
  • 3. PURPOSE OF THE STUDY
    Examine the profitability of 63 publicly available Technical Trading Systems (TTS)
    Which systems work the best and why?
    Currency pairs
    Technical indicators
    Exit technique
    Complexity/sophistication
  • 4. PURPOSE OF THE STUDY
    Expand the understanding of Technical Analysis
    Technical analysis - “the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends” (Murphy, 1999)
    TA historically disregarded by academia due to its conflict with the efficient market hypothesis (EMH)
    Sparse coverage of TA at the college level
    TA is widely used by practitioners creating a large gap between “the classroom” and “the street”
  • 5. INTRODUCTION – Efficient Market Hypothesis (EMH)
    What is the Efficient Market Hypothesis (EMH)?
    Dominant paradigm in financial theory from the 60s to the 90s
    Markets created by hyper-rational decision makers
    No one can beat the market except by luck or by taking on risk
    Therefore TA and FA should not work
  • 6. INTRODUCTION – Efficient Market Hypothesis (EMH)
    Prominent Critics
    Warren Buffett - Investor
    John Maynard Keynes – Economist
    Robert Haugen – Professor at UC Irvine
    Paul McCulley – Managing director at PIMCO
    The field of behavioral finance
    All practitioners using fundamental and/or technical analysis
    Universities now expanding beyond EMH but still very few classes on Technical Analysis
    Skepticism of TA slow to change
  • 7. INTRODUCTION – Technical Analysis
    Purpose of Technical Analysis
    To capitalize on market inefficiencies (e.g. trends)
    Types of TA Methods
    Qualitative – Charting (pattern finding)
    Quantitative – Technical indicators, trading systems
    Used in this study
  • 8. INTRODUCTION – Technical Analysis
    Tenets of Technical Analysis
    Market action (price and volume data) efficiently summarizes all microeconomic, macroeconomic and behavioral information
    Prices move in trends
    History repeats itself
  • 9. INTRODUCTION – Chart with Technical Indicators
  • 10. INTRODUCTION – The Foreign Exchange Market
    Floating Rate Foreign Exchange Market
    Also called forex or FX market
    Began in early 70s
    All currencies are quoted in relation to another
    EURUSD = Price of the Euro in relation to the US Dollar
    To buy one currency you must also sell another
    Daily turnover = 2 trillion USD
    Several times greater than all stock exchanges in the world combined
    TA used extensively in forex market
  • 11. INTRODUCTION – The Foreign Exchange Market
    • TA use in the foreign exchange (forex) market
    • 12. Taylor and Allen (1992)
    • 13. 90% of UK forex respondents use some form of TA
    • 14. Cheung & Chinn (2001)
    • 15. 30% of US forex market practitioners would best describe themselves as TA traders
    Source: Cheung & Chinn (2001)
  • 16. BACKGROUND AND LITERATURE REVIEW
    Early Studies – TA in the Stock Market (60s & 70s)
    Widely cited studies from the 60s find TA to be unprofitable
    Fama and Blume (1966)
    Van Horne and Parker (1967, 1968)
    Jensen and Benington (1970)
    Fama declares TA to be a futile undertaking (1970)
    Note: Fama is the founder of the Efficient Market Hypothesis
  • 17. BACKGROUND AND LITERATURE REVIEW
    Early Studies – TA in the Forex Market (60s, 70s & 80s)
    In contrast, TA studies in FX market generally found sizable net profits
    Poole (1967)
    Dooley and Shafer (1976)
    Logue and Sweeney (1977)
    Logue, Sweeney and Willett (1978)
    Cornell and Dietrich (1978)
    Dooley and Shafer (1983)
    Sweeney (1986)
    Schulmeister (1987)
    Shortcomings in study methodologies
  • 18. BACKGROUND AND LITERATURE REVIEW
    Modern Studies
    Address shortcomings found in early studies
    Mixed results on profitability
    56 of 95 (59%) - positive returns
    20 of 95 (21%) - negative returns
    19 of 95 (20%) – mixed results
    Source:
    Park, Irwin (2007)
  • 19. BACKGROUND AND LITERATURE REVIEW
    Survey of literature for TA in forex market
    Menkhoff, Taylor (2007)
    Review of 44 academic studies
    Conclusion
    Beyond question that TA may be used to provide very high returns
    TA is an intrinsic part of the forex market
    For researchers, this means TA must be understood and integrated into economic reasoning
    For practitioners, TA strategies must be constantly evaluated as potentially important tools
  • 20. METHODOLOGY
    What makes my study unique?
    Number of Technical Trading Systems – 63
    To my knowledge, 23 is the max in other studies
    Time frame
    1975 – 2010 (35 years)
    Results geared towards finding the best technical trading systems rather than refuting EMH
  • 21. METHODOLOGY
    Select target market [forex], vehicles [7 major currency pairs] and time frame [daily]
    Gather publicly available trading strategies [63 total]
    Common usage
    Ammermann, Conceicao (2010)
    CSULB Finance Professor and CSULB Alum
    Bollinger (2002)
    Elder (1993)
    Katz (2000)
    Leip (2010)
    Systems and indicators I created
    Murphy (1999)
    Pruitt, Hill (2003)
  • 22. METHODOLOGY
    Program the 63 Strategies into TradeStation
  • 23. METHODOLOGY
    Bifurcate the available data and run optimizations on recent ½ (in-sample) to generate optimal inputs for the strategy
    63 strategies * 7 currency pairs = 441 optimizations
    69,030 average tests * 441 = 30,442,230 total tests
  • 24. METHODOLOGY
    Organize the results and apply a scoring metric to all tests
    Select the top performing test from each of the 441 optimizations. Apply to the older ½ of the data (out-of-sample) and save results
    Gather the 441 out-of-sample results and analyze
  • 25. METHODOLOGY
    TradeStation Software Platform
    Gold standard for rule based trading
    Expensive - $100/month
    Recipient of numerous awards
  • 26. HYPOTHESES
    H1 –Technical Trading Systems will have out-of-sample excess profits that cannot be accounted for by the bearing of risk
    H2 – The more complex Technical Trading Systems will outperform less complex ones
    Excess profit test
    Sharpe Ratio – Calculates excess returns over the risk free rate
  • 27. RESULTS
    Avg. Sharpe Ratio by Strategy
  • 28. RESULTS
    Avg Sharpe Ratio by Complexity (1=simple, 5=complex)
  • 29. HYPOTHESES – Expected Results
    H1 – Sharpe ratios indicate that Technical Trading Systems have out-of-sample excess profits that cannot be accounted for by the bearing of risk
    H2 – Sharpe ratios indicate a clear link between excess risk adjusted returns and complexity
  • 30. APPENDIX - RESULTS
    Avg. Sharpe Ratio by Currency
  • 31. APPENDIX - RESULTS
    Avg. Sharpe Ratio by Technical Indicator
  • 32. APPENDIX - RESULTS
    Avg. Sharpe Ratio by Exit Type
  • 33. APPENDIX - RESULTS
    Avg. Sharpe Ratio by Source
  • 34. Question & Answer
    Thank you for your time