A few years ago I designed a day trading system for the forex based on the following assumptions:
Bulls favor an orderly, steady march higher.
This can be seen in
a. Smaller daily ranges as the market climbs.
b. Declining volatility. (less daily variance).
c. Declining put/call ratio. (less desire to purchase downside insurance)
With time, complacency shifts to greed. Bulls are less likely to buy currencies for fear of giving up top end growth. The television's pundits tell us why "This bull is different." Any unknown investor feels secure enough to enter individual positions directly. The rising tide of the market begins to float all issues.
Wide ranges and exceptional volatility create mass confusion.
This can be seen in
a) Large daily ranges as the swings from positive to severely negative.
b) Expanding volatility. (large daily variance) c) Rising put/call ratio. (strong willingness to protect what equity is left)
Open interest in currencies begins to rise. Investors try to protect their money through the purchase of other currencies as the market declines. These purchases are made in an increasingly volatile market and are marked up. Ultimately, panic sets in and we get some kind of flush where currencies are dumped, investors head to the sidelines and currencies are purchased in a rush. This creates the common "spike" bottom. A single day's events can create the reversal necessary to set the bull/bear cycle in motion again.
The interest in today's article comes from the wide range of data now available to us. I've spent some time analyzing the option data. Finally, I can track open interest on different currencies as well as volume. I was interested to find out which component was more important; volume or, open interest. Is daily activity a better predictor of market direction or, am I better off tracking the movement of currencies?
Would this data be the better predictor? As it turned out, the volume of traders generated by panic, combined with the direction of the market's volatility was still the single one, two indicator of future short-term stock market direction. The correlation between open interest and market direction was random, at best.
Frequently, very frequently, the process of analysis bears very little tangible proof. Seemingly logical and fundamental truths of market behavior produce no better than random results when subjected to the rigors of quantifiable testing methodologies. Thus, a robust system in place for several years has withstood another attempt at, "improvement."
Source: http://www.ArticlePros.com/author.php?SupremeForex
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