Meta-Trader - FX-Regression 2012

Welcome Back Meta-Traders.

In this post, let’s re-examine my own Expert Advisor FX-Regression. Albert Einstein said the definition of insanity is when you keep on doing the same thing over and over again and expecting a different result. So am I insane to keep trading this system? It hasn’t made much money, but it wasn’t wiped out either. So what can we learn from this system and how can we take it to the next level?

First let’s start with the basics. FX-Regression is based on the idea that at the end of the trading day, the price of a currency pair will deviate from its closing value by some amount then return to its closing value before the end of the next trading day a high percentage of the time. How often this condition occurs is of course dependent upon the distance of the deviation. Based on the live parameters I’m using, trades are closed at a profit approximately 75% of the time. That ties into the risk reward ratio as described below.

Here is the logic breakdown:

• Wait for the daily closing hour - 12 Noon EST for most Europe-based pairs and 4PM EST for USD/CAD.
• Place a sell order a TP distance above the market and a buy order a TP distance below the market. Wait for either order to fill or when it does cancel the opposite order. If neither order is filled in 6 hours, cancel both orders and wait for tomorrow.
• Take profit when the price returns to the daily close
• Stop loss when the price exceeds SL, generally between 2.5 to 3.0 times the Take Profit.

The premise behind this system is that absent economic influences, currency prices will complete at least one high-low rotation in each 12 hour period with approximately 6 hours between each peak and trough. The rotation is more pronounced in a trend less or low volume environment.

I can’t tell you what’s behind the movements, but the timing should be a pretty big clue. If you want to know more, you will have to buy the book “Delta Phenomenon: or The Hidden Order Behind All Markets” by Wells Wilder. The book has a $150 price tag and there is a pretty interesting story behind it, which you can read on the Delta Society web site here.

In my first version of FX-Regression, the TP and SL were calculated in terms of Pips. For EUR/USD and USD/CHF, I used a 20-pip TP and a 55-pip SL. For USD/CAD, I used a 15-pip TP and and a 55-pip SL. For EUR/USD and USD/CHF, note that the stop loss is just under 3 times the TP, so of the 75% winning ratio holds, the system should have a narrow advantage.

How do I arrive at these parameter values? I ran a 10-year backtest on EUR/USD and optimized for TP and SL values and the results are shown on the left. Take Profit pips are on the X or horizontal axis and Stop Loss Pips are on the Y or vertical axis. The solidly profitable areas of the system are in mostly in the lower TP values on the left side of the chart.

Now the first thing Daniel would say about this system is that the back test results are unreliable because the TP values are too small for the back test results to be considered reliable. 10-year optimization of the TP and SL values yields that most of the profitable area of the parameter space is toward the lower parameter sets, with take profits between 20 and 40 pips and solidly profitable for all stop values. This may be an illusion, however due to bar interpolation errors in the back tester.

What about other parameter values? As we go to higher parameter values, the system is still profitable, but trades much less often. Also, profit decreases and draw down increases considerably.

The system also suffers from a lack of reproducibility between back-tests and forward testing. In a prior post, I did a back-test to live test consistency check and found live trades that didn’t appear in the back-test and vice versa. This is another difficulty of systems which use small TP values.

So in the face of these difficulties, I was left with the choice of should I trade this system? I could not prove it was profitable, but neither could I prove it was unprofitable. I tested a lot of other systems that were a complete disaster in back testing, and there was clearly no point in pursuing those systems. So I started live trading at the beginning of 2011 with a small amount of money ($1000) to see what would happen.

Here it is, one year later and the system turned a small profit for 2011, but only as a result of pip rebates. I made several attempts to improve the system in 2011, and we will cover those efforts and the results in tomorrow’s post.

Enjoy your Saturday.