src presentation technical trading systems in forex
DESCRIPTION
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 2/25/11TRANSCRIPT
Brian Leip
PROFITABILITY OF AUTOMATED TECHNICAL TRADING SYSTEMS IN THE FOREIGN EXCHANGE MARKET
College of Business AdministrationFinance Major, CBA Honors ProgramSupervisor: Dr. Pamela Miles Homer
OUTLINE
I. Purpose of the StudyII. IntroductionIII. Background and Literature ReviewIV. MethodologyV. HypothesesVI. Results
PURPOSE OF THE STUDYExamine the profitability of 63
publicly available Technical Trading Systems (TTS)Which systems work the best and why?
Currency pairsTechnical indicatorsExit techniqueComplexity/sophistication
PURPOSE OF THE STUDYExpand the understanding of Technical
AnalysisTechnical 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”
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 riskTherefore TA and FA should not work
INTRODUCTION – Efficient Market Hypothesis (EMH)Prominent Critics
Warren Buffett - InvestorJohn Maynard Keynes – EconomistRobert Haugen – Professor at UC IrvinePaul McCulley – Managing director at PIMCOThe field of behavioral financeAll practitioners using fundamental and/or
technical analysis
Universities now expanding beyond EMH but still very few classes on Technical AnalysisSkepticism of TA slow to change
INTRODUCTION – Technical AnalysisPurpose of Technical Analysis
To capitalize on market inefficiencies (e.g. trends)
Types of TA MethodsQualitative – Charting (pattern finding)Quantitative – Technical indicators, trading
systemsUsed in this study
INTRODUCTION – Technical AnalysisTenets of Technical Analysis
1. Market action (price and volume data) efficiently summarizes all microeconomic, macroeconomic and behavioral information
2. Prices move in trends
3. History repeats itself
INTRODUCTION – Chart with Technical Indicators
INTRODUCTION – The Foreign Exchange MarketFloating Rate Foreign Exchange Market
Also called forex or FX marketBegan in early 70sAll 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 anotherDaily turnover = 2 trillion USD
Several times greater than all stock exchanges in the world combined
TA used extensively in forex market
INTRODUCTION – The Foreign Exchange Market
Source: Cheung & Chinn (2001)
TA use in the foreign exchange (forex) market Taylor and Allen (1992)
90% of UK forex respondents use some form of TA Cheung & Chinn (2001)
30% of US forex market practitioners would best describe themselves as TA traders
BACKGROUND AND LITERATURE REVIEW
Early Studies – TA in the Stock Market (60s & 70s)Widely cited studies from the 60s find TA to
be unprofitableFama 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
BACKGROUND AND LITERATURE REVIEWEarly Studies – TA in the Forex Market
(60s, 70s & 80s)In contrast, TA studies in FX market generally
found sizable net profitsPoole (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
BACKGROUND AND LITERATURE REVIEW
Modern StudiesAddress shortcomings found in early studiesMixed results on profitability
56 of 95 (59%) - positive returns20 of 95 (21%) - negative returns19 of 95 (20%) – mixed results
Source: Park, Irwin (2007)
BACKGROUND AND LITERATURE REVIEWSurvey of literature for TA in forex market
Menkhoff, Taylor (2007)Review of 44 academic studies
ConclusionBeyond question that TA may be used to provide
very high returnsTA is an intrinsic part of the forex marketFor researchers, this means TA must be
understood and integrated into economic reasoning
For practitioners, TA strategies must be constantly evaluated as potentially important tools
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
METHODOLOGY1. Select target market [forex], vehicles [7 major
currency pairs] and time frame [daily]
2. 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)
METHODOLOGY
3. Program the 63 Strategies into TradeStation
METHODOLOGY
4. 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
METHODOLOGY
5. Organize the results and apply a scoring metric to all tests
6. 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
7. Gather the 441 out-of-sample results and analyze
METHODOLOGY TradeStation Software Platform
Gold standard for rule based trading Expensive - $100/month Recipient of numerous awards
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
RESULTS Avg. Sharpe Ratio by Strategy
RESULTS Avg Sharpe Ratio by Complexity
(1=simple, 5=complex)
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
APPENDIX - RESULTS Avg. Sharpe Ratio by Currency
APPENDIX - RESULTS Avg. Sharpe Ratio by Technical
Indicator
APPENDIX - RESULTS Avg. Sharpe Ratio by Exit Type
APPENDIX - RESULTS Avg. Sharpe Ratio by Source
QUESTION & ANSWER
Thank you for your time