Improving Trading Probabilities through Regression Analysis
Date: August 31, 2005 14:00GMT
Expert: Carley Garner, Currency Analyst Alaron Las Vegas Division
- Brief description of the Odds involved in fx trading
- The usefulness of the information provided by regression analysis
- How to run a simple regression analysis using Microsoft excel
Who is Carley Garner?
Carley Garner is a Magna Cum Laude graduate of the University of Las Vegas Nevada, from which she earned a B.S. in Finance & Accounting. At UNLV she was a Dean’s List scholar and was elected to the Golden Key International Honor Society. In 2003 she was one of only 1200 collegians nationwide named to the National Society of Collegiate Scholars. Long fascinated by money and the markets, she previously worked for a stock brokerage, honing her skills at technical analysis. Although relatively new to the industry, Carley has been featured in several national publications including Futures Magazine, Active Trader and Stocks and Commodities.
FX trading requires patience, skill, dedication and, most of all, luck. As long as traders are still searching for the “Holy Grail”, there will be a constant flow of new and exciting ways to make money in the currency markets. However, experienced traders will tell you that it is easier said than done. The secret to profitable trading is the ability to manage both risk and probabilities.
Traders can improve their understanding of the currency market, as well as the odds of successful trading through statistical analysis. Studies such as correlation and linear regression may provide traders with the background knowledge necessary to make educated speculations on future price movement.
Perhaps the most important analytical tool for examining the relationships between two or more variables is regression analysis. By definition, regression analysis is a statistical technique for developing an equation that describes the relationships between two or more variables. All of this can be done with little effort through Microsoft Excel. In order to give this topic the attention and detail it deserves, it would be necessary to write an entire book. Thus, I will do my best to condense the concept into this short report. However, if you are truly interested in using regression analysis in your trading efforts it is imperative that you do your homework. There are a plethora of books available that will aid your understanding of the topic. Keep in mind, statistical analysis is a multistage process of trial and error, and should be seen as guidance as opposed to a sure fire way to make money.
The simplest case is one in which the two variables are being examined. In the regression equation below, y refers to the dependent variable with the independent or explanatory variable denoted by x. This equation is only valid if the relationship between y and x is believed to be linear. In other words if there is a valid correlation, whether it is positive or negative, the relationship between the two variables can be expressed by the following equation:
y = b0 + b1x
If a graph of all the (x,y) pairs is constructed, then b0 represents the y intercept. This is the point at which the line crosses the vertical (y) axis, and b1 represents the slope of the line. Simply put, the slope represents the relation:
You are probably wondering what the importance of this is. If we know the starting point, b0, and the slope, b1, and one of the variables, either y or x, we can estimate the fair value of the other. Any discrepancy in the market can be seen as an opportunity due to the natural correlation of the two variables.
Once again, for our purposes it is not necessary to understand the formula that is used to define the relationship between our variables (the slope) or even the starting point (b0). We will leave all of the mathematics up to Microsoft Excel.
Using the same variables and data from our previous session on correlation analysis, we will attempt to define the relationship between the Swiss Franc and the Euro paired against the Dollar.
Once selected, the data is ready to be analyzed for correlation and linear regression. Through Microsoft Excel, a click on the Tools tab will reveal a drop down menu, which will have a Data Analysis option. An “Analysis Tool” window will be displayed allowing you to chose which kind of analysis you are interested in conducting on the data sample. In this case we will chose Regression.
From there you will be prompted to enter an “input range”. In other words, which data would you like to be considered in the analysis? Click and drag your mouse over the data that you would like to be involved in the calculation and press “OK” in the window….Microsoft Excel will do the rest. The result will be a table, providing the correlation coefficient and regression output relative to the data of the chosen currency pairs.
The calculation will produce a table such as the one below, in which the correlation of the variables is measured and can be used to define their relationship. For our purposes, we will keep it simple and only focus on a few key numbers. The digits labeled Multiple R is a measurement of correlation, X Variable 1 represents the slope, b1 , and the y intercept, b1, is labeled intercept.
|Adjusted R Square||0.934459114|
|X Variable 1||0.619499711||0.008819319|
Armed with this knowledge, a trader can attempt to predict price movement by plugging the current price of one currency into the linear regression formula and solving for the other. For Example, if the Franc is trading at 7947 then according to the model the euro should be at 120.93 as seen below.
79.49 = 4.55 + .6195x
Solve for x, x = 120.93
Obviously, the relationship between these two variables is constantly adjusting to fundamental and technical market pressures. Thus, it is necessary to recalculate the regression from time to time.
As previously mentioned, although these calculations are based on statistics and could improve the odds of success, regression analysis should be used as a tool in conjunction with others. Similarly, the results of the calculation should guide the direction of the trade but not be used as exact targets.
Fxstreet Moderator (Aug 31, 2005 10:12:13 AM)
Today I am delighted to welcome back our guest and good friend Carley Garner of Alaron Las Vegas Division.
Carley (Aug 31, 2005 10:13:10 AM)
We are going to attempt to discuss regression analysis and its usefulness to traders....
Carley (Aug 31, 2005 10:14:17 AM)
I say attempt because the topic can get extremely confusing and tedious, but for our purposes we will try to keep things basic.....as we have said many times before: When trading it is always best to keep it simple.
Carley (Aug 31, 2005 10:14:49 AM)
Complexity causes confusion, and potentially losses.
Carley (Aug 31, 2005 10:15:02 AM)
The first question:
Carley (Aug 31, 2005 10:15:19 AM)
what are reg. analysis? email@example.com
Carley (Aug 31, 2005 10:15:27 AM)
That is a great question
Carley (Aug 31, 2005 10:15:57 AM)
Regression analysis is a "big word" to describe a linear relationship between two variables
Carley (Aug 31, 2005 10:16:44 AM)
In other words, if two currency pairs are correletated, whether positive or negative, they have a linear relationship.
Carley (Aug 31, 2005 10:17:38 AM)
Simply put, how much does currency A move when currency B moves X amount of pips.
Carley (Aug 31, 2005 10:18:36 AM)
Carley (Aug 31, 2005 10:18:40 AM)
May I have more information about Carley Garner and have her email address, please? alex@dejafu. com
Carley (Aug 31, 2005 10:19:17 AM)
I am flattered...perhaps this will be my favorite question for today's session.
Carley (Aug 31, 2005 10:19:36 AM)
I can be contacted at 1-800-935-6492, or firstname.lastname@example.org
Carley (Aug 31, 2005 10:20:09 AM)
I am a broker/analyst/trader educator
Carley (Aug 31, 2005 10:20:34 AM)
In other words, I work way to many hours and have no social life...but I guess that is a whole different subject.
Carley (Aug 31, 2005 10:21:29 AM)
You will find material that I have posted on several educational sites, as well as articles published in many magazines. Included are Futures Mag, Stocks and Commodities and Active Trader.
Carley (Aug 31, 2005 10:23:15 AM)
Keep in mind, being published doesn't mean that I can tell the future and I know exactly where the markets is going. It simply means that I work very hard.
Carley (Aug 31, 2005 10:23:32 AM)
Enough about me....next question.
Carley (Aug 31, 2005 10:23:52 AM)
Is it objective to use regression analysis in FX trading? Has it limitants for day trading or microtrading? email@example.com
Carley (Aug 31, 2005 10:25:01 AM)
Using regressin analysis is an objective practice, however, traders should avoid relying on the information too much.
Carley (Aug 31, 2005 10:25:28 AM)
Just as you would use any other trading tool, you must view regression data as guidance.
Carley (Aug 31, 2005 10:25:56 AM)
Trading soley on this information will likely cause you to hold a "trade gone bad" for much too long....we all know how painful that can be.
Carley (Aug 31, 2005 10:26:25 AM)
As far as limitaions for day trading and micro trading, yes you have a very valid point.
Carley (Aug 31, 2005 10:26:54 AM)
If you are running regression on daily data, it may not be a great idea to micro trade using the results.
Carley (Aug 31, 2005 10:27:32 AM)
However, by using intraday data such as 10 minute bars or less you will have better results in your day trading ventures.
Carley (Aug 31, 2005 10:27:42 AM)
Carley (Aug 31, 2005 10:27:56 AM)
Carly how might one incorporate correlation analysis information into a simple spot forex trading strategy? firstname.lastname@example.org
Carley (Aug 31, 2005 10:28:34 AM)
Like i previously mentioned, this should be used simply as guidance.
Carley (Aug 31, 2005 10:30:07 AM)
If you trade using a specific indicator, or a combination of indicators you might want to filter your signals using correlation and regression results.
Carley (Aug 31, 2005 10:31:38 AM)
For example if your indicators give a buy signal, but going long would be contradictory to the historical relationship of the currency in question along with a constant varialbe you might want to bypass the trade.
Carley (Aug 31, 2005 10:32:14 AM)
You are probably wondering how anyone could possibly do this type of calculation quick enough during a day trading session.
Carley (Aug 31, 2005 10:32:26 AM)
Well you are right, it really isn't feasible.
Carley (Aug 31, 2005 10:32:52 AM)
But, what you can do is do your homework before the trading day as a means of forming a market bias.
Carley (Aug 31, 2005 10:34:05 AM)
Rember, trading is an art not a science. Thus you must trade it with this in mind. There is no mathematical formula that will guarantee profits, there are only those that can be helpful.
Carley (Aug 31, 2005 10:34:12 AM)
Carley (Aug 31, 2005 10:34:24 AM)
I need to learn charting do you offer that? email@example.com
Carley (Aug 31, 2005 10:35:24 AM)
Yes of coarse!! We offer free online trading seminars in which we cover technical analysis. You can sign up by emailing me at cgarner@alaron .com, or visiting our educational site www.commoditytradingschool.com.
Carley (Aug 31, 2005 10:35:56 AM)
Because you asked, we will plan on covering charting techniques in our next Q&A session.....thanks for the input.
Carley (Aug 31, 2005 10:37:01 AM)
Carley (Aug 31, 2005 10:37:39 AM)
Hi! Sorry for my ignorance but, is Regression Analysis the relationship between a set of independent variables and a dependent variable? Like the price of a house (independent) and the time it takes to sell it (dependent)? firstname.lastname@example.org
Carley (Aug 31, 2005 10:37:57 AM)
Yes, you are exactly right.
Carley (Aug 31, 2005 10:38:34 AM)
Regression analysis is a statistical procedure that can be applied to nearly anything.
Carley (Aug 31, 2005 10:39:17 AM)
Forex and Futures markets are only one use of this type of study.
Carley (Aug 31, 2005 10:40:16 AM)
The easiest way to look at it is this:
Carley (Aug 31, 2005 10:41:32 AM)
If currency A moves X pips, then currency B should have moved X number of pips. If not, you can execute a trade in attempt to take advantage of the abnormality.
Fxstreet Moderator (Aug 31, 2005 10:42:46 AM)
Please post your questions now and Carley will attempt to answer as many as possible.
JSB (Aug 31, 2005 10:43:35 AM)
Carley I can't find Data Analysis under tools. And I have searched other tabs and lists for regression but cannot find it. Do u have any suggestions? I'm using the Office 2000 version.
Carley (Aug 31, 2005 10:44:42 AM)
Excel doesn't normally come with the data analysis tools already installed, you must install an additional plug in that comes with the Microsoft Office Pack.
Carley (Aug 31, 2005 10:46:00 AM)
You should be able to find an option for "Add Ins" on the Tools menu.
Carley (Aug 31, 2005 10:47:23 AM)
By clicking on this you should be given the ability to choose the analysis toolpak, from there you will be provided with the instructions necessary to install the statistical analyis tools.
jxntrader (Aug 31, 2005 10:48:02 AM)
What specifically is regression analysis showing today that can help me trade, for example, the USD/CHF pair ?
Carley (Aug 31, 2005 10:49:19 AM)
If you would like to trade the USD/CHF pair, you might want to run a regression anlysis on the Eur/USD pair against the USD/CHF pair.
Carley (Aug 31, 2005 10:49:52 AM)
The result will give you an idea of how the two pairs move together.
Carley (Aug 31, 2005 10:50:48 AM)
By knowing this, you can input the price of the Euro into the regression equation in order to extimate where the "Franc" should be trading.
Carley (Aug 31, 2005 10:50:56 AM)
Once again, guidance is the key here.
Carley (Aug 31, 2005 10:51:10 AM)
Be careful not to trade solely on this information.
Carley (Aug 31, 2005 10:51:33 AM)
However, it is good to know what the statistical projection of a currency pair is.
Carley (Aug 31, 2005 10:51:59 AM)
After all, if you are using statisitics you are putting the odds in your favor!!
fixer (Aug 31, 2005 10:52:43 AM)
how do you use your knowledge on the function of 1 pair to the other? spread trading on the difference? using the 2 pairs to eliminate usd moves?
Carley (Aug 31, 2005 10:54:44 AM)
Yes, you can use this information to try to trade the spread if it appears as though the relationship is "out of whack".
Carley (Aug 31, 2005 10:56:31 AM)
As far as using the pairs to eliminate USD moves, I haven't really experimented with that but it is an interesting idea. However, I am a little skeptical. It seems like something that may look good on "paper" but really doesn't work out in the trading world.
Carley (Aug 31, 2005 10:56:43 AM)
I will have to keep that in mind.
Carley (Aug 31, 2005 10:57:27 AM)
Like I mentioned before, the best use of this information is simply to form a bias going into the day.
CN (Aug 31, 2005 10:57:59 AM)
What currency pairs do you suggest to analyse?
JSB (Aug 31, 2005 10:59:00 AM)
In ur example "79.49=4.55+.6195x" could u explain what "x" is? And when u say "solve for x1,x=120.93" what are those "x"s?
Carley (Aug 31, 2005 10:59:31 AM)
I will answer CN's question first.....
Carley (Aug 31, 2005 11:00:12 AM)
It really doesn't matter which pairs you analyze as long as you are interested in trading them.
Carley (Aug 31, 2005 11:00:29 AM)
OK, JSB has a good question.
Carley (Aug 31, 2005 11:00:36 AM)
The X represents the value of the Euro.
Carley (Aug 31, 2005 11:01:47 AM)
By knowing the that the Franc is trading at 7949, you can solve for X by subtracting the slope from the value of the Franc and dividing both sides by the slopw(.6195).
Carley (Aug 31, 2005 11:01:57 AM)
The result is 120.93
Carley (Aug 31, 2005 11:02:27 AM)
In other words, based on the historical relationship if the Franc is at 79.49 the Euro should be at 120.93.
jxntrader (Aug 31, 2005 11:04:04 AM)
have you performed regression analysis recently to determine any relationship between the spot currency price and the futures contract price for a particular currency - for example a relationship b/w the GBP/USD pair and the British Pound futures contract
Carley (Aug 31, 2005 11:04:50 AM)
This is a great question, unfortunately I have not done a study of the relationship.
Carley (Aug 31, 2005 11:05:40 AM)
But if you do, please email the results to me. It would be interesting to see.
Carley (Aug 31, 2005 11:06:45 AM)
I am assuming that they have a very positive correlation, and the linear relationship is close to 1.
Carley (Aug 31, 2005 11:07:09 AM)
In other words, for every pip move in the spot market there will likely be a pip move in the futures
Carley (Aug 31, 2005 11:09:06 AM)
However, because futures markets are speculating on the spot price at delivery of the futures contract the futures price might be a little more volatile in that the futures price might lead the spot or lag giving it bigger swings.
Carley (Aug 31, 2005 11:09:35 AM)
However, the movement in the long run should balance out giving it a perfect positive correlation.
Fxstreet Moderator (Aug 31, 2005 11:10:04 AM)
JSB (Aug 31, 2005 11:11:25 AM)
Is there a function in the data analysis software that performs the last equation in ur last example?
Carley (Aug 31, 2005 11:12:10 AM)
Excel has a lot of functions that I am unaware of, not to plug Microsoft, but the software is great.
Carley (Aug 31, 2005 11:13:23 AM)
To my knowledge Excel does not have the ability to solve equations without actually entering the calculation into the spreadsheet manully as formulas.
Fxstreet Moderator (Aug 31, 2005 11:14:22 AM)
Thank you very much for that, Carley
Carley (Aug 31, 2005 11:14:34 AM)
No problem, thank you.
Fxstreet Moderator (Aug 31, 2005 11:14:51 AM)
• If your question was not answered during the course of this chat, please contact Carley Email: Carley.Garner@alaron.com
Carley (Aug 31, 2005 11:15:02 AM)
I would like to remind everyone to visit our website, www.commoditytradingschool.com.
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Carley (Aug 31, 2005 11:15:40 AM)
We do offer managed FX accounts, if you are interested contact me at firstname.lastname@example.org or 1-800- 935-6492. To see our track record visit :
Carley (Aug 31, 2005 11:15:58 AM)
Fxstreet Moderator (Aug 31, 2005 11:16:15 AM)
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Carley (Aug 31, 2005 11:16:36 AM)
I look forward to hearing from you!!!! Thanks again.
Fxstreet Moderator (Aug 31, 2005 11:16:47 AM)
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