Access to foreign exchange trading has opened up exciting trading options for the retail trader. You can now trade alongside corporations and institutions in a highly liquid market that is global, traded around the clock, and highly leveraged. Before jumping into this market, however, we must understand the factors that affect the forex market. With that in mind, STOCKS& COMMODITIES has introduced Forex Focus to better prepare the retail trader to participate in the currency market.
The Trend Determining Method
by Aleksey Yudin
This model is based on the theory of determined chaos, which posits that accurate market forecasts can be generated when trading the currency markets.
Determined chaos theory has attracted many followers in recent years in various fields of knowledge. Unfortunately, along with its many advantages, such nonlinear methods of analysis have their own deficiencies -- namely, the very short time horizon for forecasts. This problem could be solved by applying additional methods with a longer time horizon for forecasting, but that would create a complex and time-consuming system. Nevertheless, it is possible to balance sensitivity and "short memory" of a method and produce trades with a high winning percentage. This can be done by applying simple models based on the theory of determined chaos.
Among system creators there is endless debate on what number or type of parameters is best used to describe the market. Most trading systems are built around one parameter -- price. Using price alone, or any indicator based solely on price, cannot explain or predict market movements with any regularity.
The system described here is based on the concept that markets are driven solely by supply and demand. Market order flow can in fact be accurately tracked by analyzing volume and open interest in conjunction with market price. While price is an important aspect of our system, it is more a product of how supply and demand interacts rather than the determining factor when it comes to market forecasts.
Because forex is traded over the counter and not through a central exchange, open interest is not available. Because futures are the derivatives of the cash market, there is a strong correlation between the two so you can use open interest from the futures contract as a proxy.
A deeper discussion of volume and open interest in different markets is beyond the scope of this article. What is important to understand is that there is a connection between open interest, volume, and price, and by exploiting this relationship, you can generate consistent profits.
THE TREND DETERMINING METHOD
The trend determining (TD) method takes into account different aspects and produces trades with an 80% success ratio. The first part of the TD method is based on the system of equations describing the market (see sidebar, "Equations describing the market").
The system has five points of equilibrium characterizing its strange attractor. In terms of system parameters, a strange attractor can be described as a set of trajectories for a system, with "strange" emphasizing the singularity of attractor properties that describes its chaotic behavior.
The main task in this system is to look for unstable/vulnerable positions of the market on the attractor. This is because such states signify turning points in a market. This is the full condition:
Excerpted from an article originally published in the November 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2008, Technical Analysis, Inc.