Src presentation technical trading systems in forex


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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 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

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