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www.tradersonline-mag.com 04.2014
above +.7 and below -.7 are usually considered to be
strong correlations and may be useful when interpreting
market dynamics.
F3) Performance Summary for this Backtest
The backtest period was calendar 2013. Commissions were taken out at € 2.80
round-turn.
Source: TradeStation
It is important to note that a correlation coefficient is
non-directional; it tells us something about the directional
movement of the two markets relative to each other but
not about the past or potential future direction of absolute
prices.
For this strategy, a negative correlation is taken as a
confirmation that the RS line signal has greater validity.
That is, a buy (sell) signal is taken based on positive
(negative) momentum in the DAX / EUR/USD RS line only
when the DAX / EUR/USD correlation is negative. After
all, if the RS line is used to point out relative movement
then it is likely to be more reliable if the correlation study
also shows the potential for divergent movement on an
absolute basis.
Note that negative correlation is the additional
condition for both long and short entry signals.
The addition of this rule had a dramatic effect on
profitability while reducing the number of trades by 55
per cent to 752, or about three per day during the one-year
test period. The per cent of trades profitable improved
slightly to 43 per cent and maintained the characteristic
of having about the same per cent profitable for long and
short side trades.
Source: www.stockcharts.com
John Murphy explains
Relative Strength Ratio
„The relative strength ratio or line
is created by dividing the price
of one market by the price of another... Any two markets
can be compared with ratios… Absolute performance
measures the actual trend of a market. Relative performance
measures its performance against other markets…. Relative
performance usually changes direction before absolute
performance.“
Correlation Coefficient
“The correlation coefficient measures the strength of a
relationship between two markets… The most important
signals are given when the correlation line moves above or
below the zero line… The correlation coefficient indicator is
especially helpful in intermarket analysis…”
John Murphy, „Trading with Intermarket Analysis“
Other Considerations
In practice, several basic conditions had to be selected
before detailing the trading signals. First, when to trade
Given that the intention was to create a day-trading strategy,
trading was restricted to only the hours when the cash DAX
index is trading despite the fact that the futures (and EUR/
USD) trade for additional hours outside those times.
The first possible entry each day is at 9 am CET,
the open of the first bar that corresponds with the cash
index trading hours. The last entry signal may be taken
no later than the open of the 5 pm bar, allowing time for
price action to develop before the end-of-session exit.
In accord with a day-trading strategy the end-of-session
exit rule closes any open positions at the open of the 5.30
pm bar, corresponding to the last bar of the cash index
trading hours.
Second, the bar interval to be used had to be
determined. The hours noted above mean that, for our
purposes, the length of the trading day is 510 minutes.
Six-minute bars were used, which means the session
is divided into 85 bars. This allows for adequate data
sampling and an ample number of trading opportunities
each day. In addition, short-duration bars offer a
manageable risk/range per bar, particularly in light of the
size of the DAX contract.
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