Fig.1:Return vs risk for paper trading in real AUD/JPY and simulated reference random walk markets. Vertical axis: annualized return, calculated as an average of independent monthly statistics, 1=100% per annum. Horizontal axis: standard deviation (RMS) of such annualized return from the same monthly statistics, same unit. Each point represents an instance of a trading system, a simulated trader; points differ by trading strategy which is subject to optimization. Black points: trading 4 fantasy markets with volatility of AUD/JPY, random by construction (no predictability or patterns). Red points: real AUD/JPY. Not all outcomes are included: in some cases, the trading did not last even a month therefore no RMS could be calculated -- there would be no other month of trading performance to compare with. In such cases the system is programmed to record a zero RMS, and such outcomes did not make it into the figure. The only other requirement is that of excluding the mean annualized returns above 5 (500%) and RMS above 20 -- happy as I am to include higher returns, they would make the picture difficult to analyze visually.

Back-testing a forex trading system

While it is true that past performance does not indicate the future, the only reliable information we have is about the past. A few important things make a difference between unbiased trading-system testing and self-delusion. Here I summarize my current understanding.

Historical LIBOR charts archive

There is quite a shortage of good historical LIBOR interest rates data charts with a selection of currencies and maturities on the net. ForexAutomaton.com has a new section for just that: find historical LIBOR charts sorted by currency, loan duration and year on our site. These are essentially graphical "dumps" of our SQL database, based on the official BBA LIBOR archive. Use the Filter feature of the list to find the data you need.

USD LIBOR rates: technical predictability overview

This article begins a series of analysis reports investigating a degree of predictability in the LIBOR rates, a popular capital cost indicator. The analysis is based on historical LIBOR interest rate data released by the British Bankers Association. I continue with the same technique proved useful in the predictability analysis of forex exchange rates, as our interest in the interest rates in general is in part provoked by the results of the latter analysis, namely:

• sometimes, one forex exchage rate can "show the way" to a number of others, or in other words, foretell (in a probabilistic or statistical sense) their movement.
• when that happens, it is usually the exchange rate with a large interest rate differential showing the way to the ones with lower interest rate differentials.

Obviously, when exploring these "loopholes" or market inefficiencies for wealth generation, an algorithmic trader or a forex trading system (an automated decision making algorithm such as the one being built here on Forex Automaton™ site) must be mindful of the picture of LIBOR rates and its evolution, albeit in a somewhat different context than a long-term money manager. Being able to predict events, even in a weak statistical sense, is even better than merely following. Besides being useful via their implications for forex forecasting, LIBORs form an underlying indicator for derivatives of their own. LIBOR futures contracts and options on such contracts are traded on the CME. How does the predictability of LIBORs compare with that of currencies? Which one, LIBOR or forex, is more attractive to trade? Answering these questions, or providing a technical analysis framework to approach the answers, while leaving the fundamentals and event-driven trends aside, this series of articles about correlation features in LIBORs will serve as a useful compliment to our set of forex correlation analysis notes. I start this new series of articles with the all-important US Dollar LIBOR.

CAD LIBOR technical predictability overview

Like the previous LIBOR predictability overviews, this document begins with historical LIBOR charts for the Canadian Dollar, continues with volatility analysis, and culminates with autocorrelations and correlations of logarithmic returns for various CAD LIBOR terms. 1-week LIBOR shows wave-like correlation pattern with a period of about 30 days on top of a positive autocorrelation. As the loan duration gets longer, the wave disappers and a more uniform positive autocorrelation emerges for the range of time lags of up to 70 days. That gets reduced to a 2-3 days wide peak around zero time lag for 12-month LIBOR. Cross-correlations between different LIBOR terms show srong predictability of the shorter range LIBOR on the basis of longer range. Motivation for this type of study has been outlined in the USD LIBOR analysis.

EUR/CHF and EUR/USD follower-leader effect: USD interest rate drop could have killed the effect

This is a follow-up report on the leader-follower correlation between EUR/USD and CHF/EUR. I say CHF/EUR and not EUR/CHF because the correlation between EUR/USD and EUR/CHF is negative; it is CHF/EUR who is found to follow behind EUR/USD with about an hour lag. To those who are new to this site: the blog focuses on applying quantitative analysis to forex in search for patterns which can be utilized for trading short range, the minimal time scale being one hour. These are postulated not to exist in efficient markets, and as usual, measuring the non-existent and writing about it is a lot of fun, just like doing the "impossible" by beating the markets. This article about EUR/CHF and EUR/USD, discussing the time evolution and time stability of the effect, also extends the time span of the observation up to the fourth quarter of 2008.

AUD LIBOR technical predictability overview

Like the previous LIBOR predictability overviews, this document begins with historical LIBOR charts for the Australian Dollar, continues with volatility analysis, and culminates with autocorrelations and correlations of various LIBOR terms. You will see that predictable patterns in AUD LIBORs are quite unique. Autocorrelations of short-term LIBORs show oscillations with about 7-8 day pediod, similar to USD but localized in the short range lags. For 3-month, 6-month and 12-month terms, broad (a few days) correlation peaks around 0 time lag are seen. For 3-month and 6-month LIBORs, the correlation is seen to be overall positive for the range of lags up to 70 or 80 days.

CHF/JPY and EUR/USD leader-follower history

This is a follow-up report on the leader-follower correlation between CHF/JPY and EUR/USD. To those who are new to this site: the blog focuses on applying quantitative analysis to forex in search for patterns which can be utilized for trading short range, the minimal time scale being one hour. These are postulated not to exist in efficient markets, and those who approach the market with that assumption, will find that the ugly asymmetric reality of forex holds little respect for that beautiful theory. The initial review of such forex inefficiencies, broad but superficial as it was, did reveal a number of specific effects to talk about. These became "acting characters" for the sequel stories, presenting in-depth studies, and tracing the characters' destinies. This article about CHF/JPY and EUR/USD, discussing the time evolution and time stability of the effect, is one of such stories. It appears that the predictability "loophole" such as this has been alive as recently as third quarter of 2008.