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Stocks & Commodities V.

26:11 (14-17): Forex Focus: The Trend Determining Method by Aleksey Yudin

FOREX FOCUS
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


This model is based on the theory of determined chaos, which
posits that accurate market forecasts can be generated when
trading the currency markets.

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

etermined 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.

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

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:
| f(t) | = | k(t) (Ce(t) C(t))| 0.6
where Ce(t) is the x-coordinate of one of a five-system
equilibrium point, and k(t) is the normalized function to the
condition |f(t)| 1. With an area of value [-1,1] we can make
the decision about the initiation or rollover of a position.
When its value gets to the buy [0.6,1] or sell [-0.6,-1]
area, we must act at the open of the next trading day.
The stop-loss level was derived from the last 10 days of

EQUATIONS DESCRIBING THE MARKET

dC(t)
= x 1(t)C(t) + x 2(t)C(t)V(t) + x 3(t)C(t)D(t),
dt
dV(t)
= y 1(t)V(t)C(t) + y 2(t)V(t) + y 3(t)V(t)D(t),
dt
dD(t)
= z 1(t)D(t)C(t) + z 2(t)D(t)V(t) + z 3(t)D(t),
dt

by Aleksey Yudin
(c) Technical Analysis Inc.
14 November 2008 Technical Analysis of STOCKS & CCopyright
OMMODITIES

Stocks & Commodities V. 26:11 (14-17): Forex Focus: The Trend Determining Method by Aleksey Yudin

FOREX FOCUS
Determined chaos has
attracted many followers
in recent years.
Unfortunately, such
nonlinear methods of
analysis have their own
deficiencies.
example of spot trading in USD/CHF from July 4, 2008, to
September 24, 2008 (Figure 1). All trades were executed
at the open. Figure 2 shows the results of the TD method
in trading the Usd/Chf from December 12, 2006, to
September 28, 2008. During this period, the system
executed 36 trades, 31 (86%) of which were profitable
with a profit factor of 17.1 and a downgrade of 2.3% with
the return of 35% a year without any margin. By applying
a 5% margin, the profit factor decreased to 15.2, the
downgrade increased to 11.6% and the system is capable
of generating profits of 400% a year.

STOCKCHARTS.COM

PROFITING IN CHAOS

FIGURE 1: APPLYING THE TD SYSTEM. Here you see an example of


the application of the TD system on the USD/CHF from August 6, 2007, to October
10, 2007.

volatility and seldom triggered. Its main task was to protect


the account from an uncharacteristically large market movement; usually in those cases, the system does not have enough
time to react.
One problem in using this approach and that is the short
memory of the system. To overcome this, we must use other
methods in conjunction to confirm or maintain the open
position.
The next part of the TD method is based on digital filtration
that solves the short memory problem. It also tells us when
to stop trading. Basically, the system filters a stream of prices,
taking away all cycles of more than 40 days and less than 10
days in length.
The system studies the spectrum of price streams for
different currency pairs by using J.P. Burgs algorithm, since
it contains all cycles of average length and allows us to use
these time intervals. The filter we have created has standard
parameters StopBand attenuation -40 dB and PassBand
ripple 0.08. As a result, we receive the active market cycle
and by using its extremes (in area) from to 2 (Gaussian
distribution), we determine when to stop trading. The same
idea was used in the AT&CF method by Vladimir Kravchuk.
When the active cycle has reached its extreme at the close, we
close our position at the next days open.
To demonstrate how the TD method works, we took an

Because the TD system can generate profitable signals


80% of the time, it greatly reduces the chance of
asignificant drawdown in your trading capital. Because of this, you can be more flexible in your money
management strategy and allocate a larger portion of your
trading capital to each trade and still remain at an acceptable level of risk/volatility.
More work needs to be done on this system to determine
if it can be extended to other asset classes such as stocks
and derivatives. We will let you know when we find anything
of significance.
Aleksey Yudin has been researching nonlinear methods as
applied to markets since 2005.

SUGGESTED READING
Burg, J.P. [1967]. Maximum Entropy Spectral Analysis,
Proc. 37th Meet. Soc. Exploration Geophysicists; reprinted
in Modern Spectrum Analysis (D.G. Childers, ed.), IEEE
Press, New York, 1978.
Cassidy, Donald [2001]. Trading On Volume: The Key To
Identifying And Profiting From Stock Price Reversals,
McGraw-Hill.
Kravchuk, Vladimir [200001]. Adaptive Trend & Cycles
Following Method, The Currency Speculator.
Shaleen, Kenneth H. [1997]. Volume And Open Interest, rev.
ed., Irwin Professional.
Williams, Tom [2005]. Master The Markets: Taking A
Professional Approach To Trading & Investing By Using
Volume Spread Analysis, www.tradeguider.com.

(c) Technical Analysis Inc.


16 November 2008 Technical Analysis of STOCKS & CCopyright
OMMODITIES

Stocks & Commodities V. 26:11 (14-17): Forex Focus: The Trend Determining Method by Aleksey Yudin

FOREX FOCUS

FIGURE 2: TRADING RESULTS (DECEMBER 29, 2005 TO OCTOBER 10, 2007). There were a total of 42 trades. Without
any margin, 81% were profitable with a 30% return per year. Adding a 5% margin increased annual returns to 260%.

Copyright (c) Technical Analysis Inc.

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