New views on the future of currency
By Winsor HoangMr. Hoang is the founder and CEO of CTS Forex, a Vancouver-based automated, statistical, risk-managed FX trading system. Using his statistical and automated system design experience at Nortel Networks, RIM and Sierra Wireless, he began developing automated systematic solutions and, in 2010, after seven years of development, testing and trading his own money, introduced CTS Forex to the market. Winsor has nearly two decades and more than twenty thousand hours of trading experience. His automated FX trading system continues to produce consistent returns, regardless of market flux. Hoang is a registered professional engineer, and holds a Bachelor of Engineer from the University of Victoria. For more information visit www.ctsforex.com.
In Burton Gordon Malkiel’s classic book, “A Random Walk Down Wall Street,” he points out flaws in the use of fundamental or technical analysis in equity trading and suggests that one cannot achieve consistent returns using these methods. Warren Buffet, in his response to Malkiel, suggested that, using the fundamental approach of value investing, could achieve consistent returns. Intrinsic to Buffet’s value investing style, however, is the philosophy of buy and hold.
Forex trading bears little semblance to equity trading. Buy and hold is not an option for a forex trader seeking consistent returns. Whereas long-term trends may be your friend in the equity market, volatility and leverage make long-term trends enemies in the unpredictable Forex marketplace. Repeated studies demonstrate that, while certain long-term trends may exist, the prudent trader must react to short-term market movements. Buy and hold forex trading is a losing proposition.
Barclay CTA Currency Trader’s Index recently reported the annual returns of the 103 currency funds averaged just 2% per annum over the last three years. Many of those funds utilize fundamental or technical analysis techniques in their decision making.
The future of currency
While the balance of payments, inflation, interest rates, debt and deficits undoubtedly play a role in the future of a currency, current events and market activity have greater influence the short term movements. In a market where reasonably high leverage is typical, short term movements mean the difference between profit and loss. So where does this leave technical analysis or fundamental analysis as a trading tool? Probably best left to lower leverage, smaller, less liquid markets such as equity and debt.
Examining the movements of the EUR/USD pair over thirteen years, I analyzed 13 years of market movements to determine the lengths of trends. Research began with daily candlestick data from 2000 to 2013, but was later revised to include four-hour charts. Expanding the study generated a larger sample size and helped avoid any potential of consecutive up or down bias. Using four-hour market movements, and creating a graph of the incidences of consecutive up or down price changes, I found that trends, while not wildly random, are also not evenly distributed and, therefore, somewhat unpredictable. Few consecutive market movements continue more than 24 hours; my observation – there are no real trends in forex. The implication is that reliance on the traditional trend analysis or prediction of long-term trends through fundamental analysis is risky, especially for those seeking to limit their exposure to market volatility.
Proponents of efficient market theory often point out that, in a simple coin toss experiment by a large number of gamblers, there would be few successive winners. However, many traders apply a similar idea by increasing positions when trend trading as well as a means of either increasing profits or recovering losses. Hoang sees the coin toss trading comparison as an oversimplification. What differentiates managers from gamblers is that fund managers do not bet the farm on each single trade. Successful managers also avoid vulnerability to short-term market reversals by avoiding parlaying or continually increasing positions. They trade with consistency, cut their losses short, and let their profits run; hence, ensuring long-term profitability.
My conclusion is that, in the absence of predictable trends in the forex market, technical and trend analysis is ineffective. Traders seeking consistent rates of return must adopt a trading methodology that is sensitive to shorter term market movements.
My research into Forex trading has led to the development of an entirely new approach to market analysis. Instead of relying upon questionable fundamental and technical techniques, I suggest using statistical analysis as a means of estimating the probability that each trade will be profitable.
Inherent in most commercial trend and fundamental based forex trading models, is the use of a single algorithm to evaluate market movements. The single model approach has not produced consistent, reliable results due to the fact that it overlooks the fact that there are three market conditions – up, down and seesaw. Each market condition, when analyzed over time, has different characteristics, as do market transitions. To be effective, a trading model (algorithm) must specialize in a particular market condition.
After discovering the pattern of the lengths of trends in each of the market conditions, I created six independent algorithms to analyze movements within up, down and seesaw market conditions. Two algorithms are assigned to each market condition and evaluate movements based upon different criteria. Performing millions of Monte Carlo simulations of past market movements, our models established criteria by which our computer automated trading software evaluates the statistical probability that a trade will result in a profit.
Seven years of development and testing in addition to three years and over 3,300 live trades have confirmed the multiple algorithms, statistical probability trading methodology produces greater returns with lower volatility than traditional trend or fundamental based trading systems. Having demonstrated that attempting to follow long-term trends is risky, our (that of CTS Forex) average trade hold time is twenty-hours with a maximum hold time of two weeks. Actual hold times depend upon severity of market movement.
No predictive system is perfect. But the goal is the same – solid returns with minimal volatility. Applying statistical analysis techniques, trading consistent lot sizes, establishing firm profit and loss points, and automating trading, my company’s statistical trading model has achieved break-even at 45% winning trades and significant returns with 50% winning trades.
In a time where geopolitical changes and economic uncertainty have so influenced market movements, the trend is away from fundamental and technical analysis, both of which are associated with longer-term market movements. The statistical approach estimates shorter term trade potential and clearly defines take profit and stop loss points as a means of consistent, positive returns.