Little reading material on the subject of noise filtering for those interested. Bumping the thread as well
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DislikedHi Guys
After the mother of all exam marking sessions, assessment committees, exam boards, graduation ceremonies, etc (and IMHO a damned well deserved holiday!!), I'm back.
Many thanks to all those good folks who PM'd me almost every day wanting to keep the thread alive.
So... where to go from here. As the thread has evolved, we might have wandered a little off topic. I am assuming that the good folk reading this are here because (1) you are mathematically and computer literate and (b) highly motivated.
The thread had started to wander into stuff like Fourier analysis and spectral methods. These are great but MUST be used with caution! I will talk more about these and their correct use for FX in the future. But to get the thread back onto the main tack....
Let us firstly remember that financial time series are NON-STATIONARY for the reasons we have discussed, and NON-LINEAR in that they are non-Gaussian. Hence, we should put RIGHT OUT OF OUR MINDS STRAIGHT AWAY any notions that arise from linear systems theory. This includes ALL the filters you will find in text books such as moving averages etc. It also includes ALL ideas from linear algebra, such as correlation.
It literally makes me weep sometimes when I see even brand new text books in economentrics banging on about "correlations between assets". Correlation is an idea that arises from LINEAR algebra. To ask if two non-stationary time series are correlated is like asking "Who married the fridge?". The question is quite meaningless. Asking if two non-stationary series are CO-INTEGRATED is quite a different matter and a highly valid question. If you ask this, you can REALLY learn something about the future!!! More later.
This may well go some way to explaining why the hedge fund I consult with is up 34% since last August while the rest of the world appears to be going to hell in a handbasket. If you base risk measures on correlation , you are DOOMED as Northern Rock, Bear Stearns, etc etc etc etc etc etc are finding out the hard way.
So, to approach FX from a hard, numerate, scientific standpoint, we argue as follows:
[1] ARE MARKETS RANDOM? If so, then we are screwed. No amount of signal processing, linear or otherwise can tell you anything at all about a random signal. So we stop right here and take up another hobby like goatkeeping and sell the cheese instead of trading the markets.
If they are not random, then we are in with a chance. The Efficient Market Hypothesis (EMH) that is STILL is the damned textbooks :-(( says the market is random and that all the information is in the current price and you can't predict the future. Luckily, everyone except economists have realised that the EMH is DEFINITELY FALSE. These is loads of empirical evidence to show that it is not true. So we have a chance.
[2] As we have argued before in this thread, what we then have is a genuine signal that we can exploit, buried in a ton of noise due to market makers buggering about and a host of other factors. So the main task in hand is to get a good (non-linear) filter to separate out our precious signal from all the noise.
Once we have that signal we can really move. I have two main trading techniques. One is high frequency trading which is perfectly suited to FX (indeed it is only applicable to FX) and uses the tick-by-tick data to uncover meta-beliefs held by market makers. That is, by looking at trade prices and MM reactions to them (up/down/same) and the time taken to revise their quote, we can learn a lot about what THEY think WE think that THEY think. More on this in future.
My other main market technique - be it FX or anything else - is to exploit co-integrated time series. These series have a genuine causal link (even if that cause is unknown) - see Grainger's Nobel Prize address on this topic. So I look for deviations from the norn and "pairs trade" - that is, go long one currency and short the other, with a very high degree of certainty that the pair will revert to their long-term cointegral relationship. With a little bit of mathematical savvy, one can remain pretty much market-neutral and just reap the profit.
There - so now you know the secret (or mine anyway). I all but live off this income (I still go into the Uni to get out from under my wife's feet when she is doing her own thing).
If there is interest in this, we will discuss details and methods.
Have a great day,
CB.Ignored
DislikedHi CB,
So happy to see you return and to know that this thread is alive again.
I am definitely interested in this topic. I am very impressed by your mathematics background (and also your humor). Please do tell us more.
Wish you have fun in trading, in mathematics, and in life.Ignored
DislikedHi Guys
After the mother of all exam marking sessions, assessment committees, exam boards, graduation ceremonies, etc (and IMHO a damned well deserved holiday!!), I'm back.
Many thanks to all those good folks who PM'd me almost every day wanting to keep the thread alive.
So... where to go from here. As the thread has evolved, we might have wandered a little off topic. I am assuming that the good folk reading this are here because (1) you are mathematically and computer literate and (b) highly motivated.
The thread had started to wander into stuff like Fourier analysis and spectral methods. These are great but MUST be used with caution! I will talk more about these and their correct use for FX in the future. But to get the thread back onto the main tack....
Let us firstly remember that financial time series are NON-STATIONARY for the reasons we have discussed, and NON-LINEAR in that they are non-Gaussian. Hence, we should put RIGHT OUT OF OUR MINDS STRAIGHT AWAY any notions that arise from linear systems theory. This includes ALL the filters you will find in text books such as moving averages etc. It also includes ALL ideas from linear algebra, such as correlation.
It literally makes me weep sometimes when I see even brand new text books in economentrics banging on about "correlations between assets". Correlation is an idea that arises from LINEAR algebra. To ask if two non-stationary time series are correlated is like asking "Who married the fridge?". The question is quite meaningless. Asking if two non-stationary series are CO-INTEGRATED is quite a different matter and a highly valid question. If you ask this, you can REALLY learn something about the future!!! More later.
This may well go some way to explaining why the hedge fund I consult with is up 34% since last August while the rest of the world appears to be going to hell in a handbasket. If you base risk measures on correlation , you are DOOMED as Northern Rock, Bear Stearns, etc etc etc etc etc etc are finding out the hard way.
So, to approach FX from a hard, numerate, scientific standpoint, we argue as follows:
[1] ARE MARKETS RANDOM? If so, then we are screwed. No amount of signal processing, linear or otherwise can tell you anything at all about a random signal. So we stop right here and take up another hobby like goatkeeping and sell the cheese instead of trading the markets.
If they are not random, then we are in with a chance. The Efficient Market Hypothesis (EMH) that is STILL is the damned textbooks :-(( says the market is random and that all the information is in the current price and you can't predict the future. Luckily, everyone except economists have realised that the EMH is DEFINITELY FALSE. These is loads of empirical evidence to show that it is not true. So we have a chance.
[2] As we have argued before in this thread, what we then have is a genuine signal that we can exploit, buried in a ton of noise due to market makers buggering about and a host of other factors. So the main task in hand is to get a good (non-linear) filter to separate out our precious signal from all the noise.
Once we have that signal we can really move. I have two main trading techniques. One is high frequency trading which is perfectly suited to FX (indeed it is only applicable to FX) and uses the tick-by-tick data to uncover meta-beliefs held by market makers. That is, by looking at trade prices and MM reactions to them (up/down/same) and the time taken to revise their quote, we can learn a lot about what THEY think WE think that THEY think. More on this in future.
My other main market technique - be it FX or anything else - is to exploit co-integrated time series. These series have a genuine causal link (even if that cause is unknown) - see Grainger's Nobel Prize address on this topic. So I look for deviations from the norn and "pairs trade" - that is, go long one currency and short the other, with a very high degree of certainty that the pair will revert to their long-term cointegral relationship. With a little bit of mathematical savvy, one can remain pretty much market-neutral and just reap the profit.
There - so now you know the secret (or mine anyway). I all but live off this income (I still go into the Uni to get out from under my wife's feet when she is doing her own thing).
If there is interest in this, we will discuss details and methods.
Have a great day,
CB.Ignored
DislikedAnyone around ? :-)
This is too good of a thread to let it die....
clIgnored