Posts Tagged ‘forex trading’

Best FOREX trading systems

Thursday, April 30th, 2009

How to determine the best forex trading system(s)?

This is the 1 million dollars question as they say.

This is the first and most important question that you should ask yourself before starting an automated forex strategy. Because anything  else depends on how you make your judgment. Not knowing that this is the main question is a big error.

Very often novice traders or bot buyers will look at the return, the backtest return or the recent out of sample return. These numbers are very often the only thing that people look at.

The truth of the matter is that these are not the correct numbers to consider when evaluating forex trading systems.

Here is a back of the envelop list of some of the elements to make your choice:

  1. Currency diversity: does the system trade one or more currency pairs?
  2. Sharpe ratio: this is a much better statistics than return;
  3. Length of back-test: obviously the longer, the better;
  4. Length of out of sample: the longer the time since release, the better;
  5. General/Specific: is the system designed for specific market conditions?
  6. Drawdown: what is the worse case scenario?
  7. Reputation: who is the designer and what is his knowledge?

Looking at past return of recent returns is the most misleading idea. Past backtested returns are easy to manipulate. Recent returns are too short to have any statistical significance. Additionally leverage can also improve these apparent returns. Curve fitting weights is another way to play with returns.

More serious considerations used to find the best forex trading systems start with the Sharpe ratio. Whatever weakness one can find in the Sharpe ratio, it is without a doubt infinitely more potent than a return, which is just a floating number without an anchor whilst the Sharpe ratio is a return anchored by its  volatility.

The Sharpe ratio is just the beginning of a thorough analysis of any system. Drawdown is a complementary measure which is a conditional type of return, the worse return during the period under review. Stress testing and scenario analysis is a more sophisticated type of analysis.

What is the big difference between a backtested track record and a real money trading record? In the first case, a drawdown seems like the drawing of a  little roller-coaster on a sheet of paper. In the second case it feels like you are sitting NOW in the steepest descending part of a real roller-coaster.

The other elements in the list will help to strengthen your decision. Double up your caution and halve your optimism.  Many people are looking for the best trading system, but few find it. Ask your forex broker if they offer any trading system.

What is the most stable currency vs. US dollar?

Wednesday, April 22nd, 2009

Do you know what the most stable currency versus the USD is, in the past one year, five year or twenty years?

Of course if you are a currency trader or if you are from that country, it is easy for you to answer. It is a currency which has almost always stayed within a 1% band versus the greenback in the past 20 years.

It is the Hong Kong dollar.

Before I start, note that the Hong Kong Dollar (HKD) dollar is the currency of Hong Kong which is part of China, whilst the Chinese Yuan or Renminbi (RMB) is the currency of mainland China. They do not have the same value (but they are close) and do not follow the same fluctuations.

The HKD’s target rate set by the Hong Kong Monetary Authority has been 7.8 HKD/USD since 1983. And since then, this “pegged rate” has almost never moved away by more than a percent; very rarely was the rate below 7.72. At the time of writing, it is at 7.75. It is always less than 7.8, usually around 7.77.

So who cares?

I care and I hope you too if you are still reading. The point is that if you are here you must be interested in currencies. And what is so special about all pegs is that they are made to be broken. An unbroken peg for 26 years is certainly almost a miracle.

Hong Kong is a relatively small country. It is “bigger” now, indeed it is part of China, but in 1983 it was small and it was not on such friendly terms with its big brother in the North as it is now. No other country, small or big, has been able to maintain a USD peg that long. The Singapore dollar also had a loose peg, but it has been shaken by wild financial crises more than once.

Hong Kong also faced financial crises, and not just the recent one. Do you remember the so-called Asian financial crisis in 1997? Then all the currencies from the “Asian Dragons” collapsed: Singapore, Taiwan and Korea, but not the 4th Dragon, Hong Kong. Other lesser dragons such as Thailand, Indonesia saw their currencies lose as much as 75% of their value against the US dollar.

Malaysia, like Hong Kong, had pegged its currency. But the consequence of the financial meltdown was truly dramatic as the convertibility of the Malaysian Ringgit was suspended, the Prime Minister took drastic measures and sent his successor to jail under accusations of sodomy.

I take off my hat to the courage and determination of the HKMA during all these years. 1998 was particularly tough, as Soros and other hedge funds took positions against HKD, but it never broke. Certainly Hong Kong has and continues to have large currency reserves and abundant wealth, but without its political firmness, it could not have sustained all these emergencies.

If you are interested in making money using forex trading systems, please cross the HKD/USD pair from your list, as the chart is a near perfect flat line. Thank God, there are many other currencies to play with.