Such an index would guide us through almost every currency trade we do. If we know that the Euro has a high probability of rising then we won’t be short the Swiss Franc, the British Pound or even the A$. A European equity manager would know when to hedge his positions in US equity and bond markets.
To create such an index we need to be confident that there are relatively few significant variables and that their significance is stable. We don’t want to make this into a complicated parametric equation requiring frequent optimizations. As much as Neural Nets are interesting they rarely produce a reliable result since their optimizer is too powerful.
The first thing we absolutely know as currency traders is that money follows yield. This inviolable rule doesn’t work in emerging markets where higher yields often start currency meltdowns rather than stem them but in the case of the Euro, interest rates tell us a lot. Their volatility and their relative movement can be used to build our “fuel gauge” and then we can add simple rules to trade by.
Paratrade has now completed such an index or gauge and its available to subscribers. This chart shows you the performance of a 1 lot in Euro futures compared to an index weighted return with a mean of 1 (range is between 0 and 2).
To be valuable the index must work in a rising market, a falling market and a stagnant market. This has generally been the case over the last ten years. If you trade the British Pound, the Swiss Franc or any other currency or currency cross that correlates with the Euro then this gauge will be valuable as a filter.
We have a longer essay that goes into the weeds and should be read by prospective users/subscribers. Click Here to download it. To become a trial subscriber go to the Paratrade website and fill in the popup or email me directly.