publication

strategies
markets, Relative Strength (RS) and correlation, to
find and filter trading signals.
Simplicity is considered a desirable trait in a trading
strategy and this style of analysis does carry the risk of
having rules that are overly complex. A guiding principle
in developing this idea was to fall on the side of simple
and straightforward in the calculations and signals by
restricting them to these two relationships.
F1) FDAX and EUR/USD 6-Minute Bars with Relative Strength
Relative Strength
A Relative Strength (RS) line, also known as a Relative
Strength ratio, is a simple technical tool used to compare
the price action in two markets. It is calculated by dividing
the price of one market by the price of the other. Although
this is often done with, say, a stock price divided by an
index, the RS line for this strategy is the result of dividing
the DAX by the EUR/USD. The numeric value of an RS
calculation is not important; rather, the direction and
momentum of the RS line let us know if the first market
is relatively stronger or weaker than the second, DAX and
EUR/USD respectively in this case.
It is not unusual to smooth an RS Line and that was
done here as well. Again in pursuit of simplicity, the RS
line was smoothed with a simple average. The length for
this average was set to ten bars. None of the parameters
in this strategy, including the length of this average, have
been optimised. Ten is not only a common default for a
calculation like this but, more importantly, it represents
one hour of trading on 6-minute bars. There is a discussion
of the bar interval later in this article.
The direction of the average of the RS line is
determined using a common momentum analysis of the
average. Specifically, the strategy determines if the 5-bar
momentum of the average is positive (for long entries) or
negative (for short entries).
During the test period, described more fully below,
this approach was marginally profitable. The results
were not strong enough to be convincing, yet some of the
metrics were of interest and called for more refinement.
It was encouraging that 39 per cent of the trades were
profitable, with about the same percentage of long- and
short-side trades being profitable. Of greatest concern,
however, was the very large number of trades that the
strategy generated, approximately 1690 or about seven
trades per day during a 1-year test.
Might it be possible to add another dimension to
the analysis by examining another relationship between
these two markets and use that to filter the trades The
goal would be to improve profitability, of course, while
reducing the number of trades.
This chart contains both DAX futures and EUR/USD. The darker bars indicate
the hours that correspond to cash DAX trading. The indicator is the 5-bar
momentum of the 10-bar average of the relative strength line.
Source: TradeStation
F2) FDAX with Relative Strength, Correlation
and Strategy Signals
EUR/USD data has been hidden. The correlation study is red when the
coefficient is less than -0.1 (not zero) to match the strategy rules. Any open
trades are closed at the end of the cash session. See the text for details on
the rules.
Source: TradeStation
Correlation
Technical analysts use correlation studies to gauge
how closely two markets track each other. Such studies
generate a correlation coefficient, a value between +1 and
-1. A correlation of +1 is a ‘perfect positive’ correlation
– the two markets are in lockstep. A correlation of -1 is
a ‘perfect negative’ correlation. Values near these, say,
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